Question

In taking a physical inventory at the end of Year 1, Grant Company forgot to count certain units and understated ending inventory by $10,000. Determine how this error effects each of the following. (a) Year 1 cost of goods sold. Overstates Year 1 cost of goods sold. Understates Year 1 cost of goods sold. None of the above. (b) Year 1 net income. Understates Year 1 net income Overstates Year 1 net income None of the above. (c) Year 2 cost of goods sold. Understates Year 2 cost of goods sold. Overstates Year 2 cost of goods sold. None of the above.

Answer 1

Answer:

a. Overstates Year 1 cost of goods sold.

b. Understates Year 1 net income

c. Understates Year 2 cost of goods sold

Explanation:

a. The formula for Calculating the Cost of Goods sold is;

Cost of Goods Sold = Opening inventory + Purchases - Closing inventory.

If the closing inventory is understated, it will reduced the amount being subtracted from Purchases and Opening inventory which would means that Cost of Goods sold will be overstated.

b. The Cost of goods sold is deducted from sales to give Gross profit. If Cost of goods is overstated, it will reduce Gross Profit higher than it should. A lower Gross Profit equates to a lower Net Income.

c. Going by the formula in a;

Cost of Goods Sold = Opening inventory + Purchases - Closing inventory.

In Year 2, the understated Year 1 closing stock will become the understated Year 2 Opening stock. With the opening stock understated, the Cost of goods will be understated as well because Opening stock is meant to increase Cost of goods sold as the formula shows. If it is understated, the amount that it will add will be understated as well.

Answer 2

a. Cost of goods sold should be Overstates for Year 1

b. The net income for the year 1 should be Understated

c. The cost of goods sold for year 2 should be Understated.

Understated and overstated of net income& cost of goods sold:

a.

We know that

Cost of Goods Sold = Opening inventory + Purchases - Closing inventory.

In the case when the ending inventory is understated so this decreased the amount that should be deducted from the purchase and the beginning inventory due to this there is overstated of the cost of goods sold.

b.

We know that

Gross profit = Sales - cost of goods sold

In the case when there is overstated of the cost of goods sold so it decreased the gross profit due to this the net income should be lower.

c. G

For the year 2, the closing stock i.e. understated in the year 1 should be the opening stock for the year 2. Due to the understated of the beginning stock, the cost of the goods sold should be understated

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