Assume that in Year 1, the ending merchandise inventory is
overstated by $30,000. If this is the only error in Years 1
and 2, fill in the items below, indicating which items will be
understated, overstated, or correctly stated for Years 1 and
2.
Item Year 1 Year 2
Ending inventory ___________ _____________
Beginning inventory ___________ _____________
Cost of goods sold ___________ _____________
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To determine how the ending inventory, beginning inventory, and cost of goods sold will be affected in Year 1 and Year 2, we need to understand the flow of these items in the financial statements.
In Year 1:
1. Ending Inventory: The ending inventory will be overstated by $30,000. This means that the reported value of the ending inventory will be higher than its actual value.
2. Beginning Inventory: The beginning inventory in Year 1 is unaffected by the error in Year 1. Therefore, it will be correctly stated.
3. Cost of Goods Sold: The cost of goods sold is calculated using the formula:
Cost of Goods Sold = Beginning Inventory + Purchases - Ending Inventory
Since the ending inventory is overstated, the reported cost of goods sold will be understated by the same amount ($30,000). This means that the cost of goods sold will be lower than its actual value.
In Year 2:
1. Ending Inventory: The ending inventory in Year 2 is calculated using the formula:
Ending Inventory = Beginning Inventory + Purchases - Cost of Goods Sold
Since the cost of goods sold was understated in Year 1, the equation will result in an overstated ending inventory in Year 2. Therefore, the ending inventory will be overstated by $30,000.
2. Beginning Inventory: The beginning inventory in Year 2 is unaffected by the error in Year 1. Therefore, it will be correctly stated.
3. Cost of Goods Sold: The cost of goods sold in Year 2 is calculated using the same formula as Year 1. Since the ending inventory in Year 2 is overstated, the reported cost of goods sold will be understated by the same amount ($30,000). This means that the cost of goods sold will be lower than its actual value.
Here's how the items will be filled in:
Item Year 1 Year 2
Ending Inventory Overstated Overstated
Beginning Inventory Correct Correct
Cost of Goods Sold Understated Understated