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A general rule is that overstatements of ending inventory cause overstatements of income, while
understatements of ending inventory cause understatements of income. For instance, compare the
following correct and incorrect scenario -- where the only difference is an overstatement of ending
inventory by $1,000 (note that purchases were correctly recorded -- if they had not, the general rule
of thumb would not hold): Correct Incorrect $ 5,000 $ 5,000 11,000 11,000 $16,000 $16,000 4,000 5,000 Cost of goods sold $12,000 $11,000 Sales $25,000 $25,000 12,000 11,000 $13,000 $14,000 Beginning inventory
Purchases **** Cost of goods available for sale
Ending inventory Cost of goods sold
Gross profit Had the above inventory error been an understatement ($3,000 instead of the correct $4,000), then
the ripple effect would have caused an understatement of income by $1,000. Inventory errors tend to
be counterbalancing. That is, one year’s ending inventory error becomes the next year’s beginning
inventory error. The general rule of thumb is that overstatements of beginning inventory cause that
year’s income to be understated, while understatements of beginning inventory cause
overstatements of income. Examine the following table where the only error relates to beginning
inventory balances: Download free ebooks at bookboon.com
44 Inventory Errors Current Assets: Part II Correct Incorrect $ 4,000 $ 5,000 11,000 11,000 $15,000 $16,000 3,000 3,000 Cost of goods sold $12,000 $13,000 Sales $25,000 $25,000 12,000 13,000 $13,000 $12,000 Beginning inventory
Cost of goods available for sale
Ending inventory ****
Cost of goods sold
Gross profit Please click the advert Hence, if the above data related to two consecutive years, the total income would be correct
($13,000 + $13,000 = $14,000 + $12,000). However, the amount for each year is critically flawed. The ﬁnancial industry needs a strong software platform
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- Fall '13