Problem 5-24A Effect of inventory errors on financial statements
The following income statement was prepared for Frame Supplies for Year 1:
|
FRAME SUPPLIES Income Statement For the Year Ended December 31, Year 1 |
|
|---|---|
| Sales | $250,000 |
| Cost of goods sold | $(140,000) |
| Gross margin | $110,000 |
| Operating expenses | $(69,500) |
| Net income | $40,500 |
During the year-end audit, the following errors were discovered:
- A $2,500 payment for repairs was erroneously charged to the Cost of Goods Sold account. (Assume that the perpetual inventory system is used.)
- Sales to customers for $1,800 at December 31, Year 1, were not recorded in the books for Year 1. Also, the $980 cost of goods sold was not recorded.
- A mathematical error was made in determining ending inventory. Ending inventory was understated by $2,150. (The Inventory account was mistakenly written down to the Cost of Goods Sold account.)
Required:
Determine the effect, if any, of each of the errors on the following items. Give the dollar amount of the effect and whether it would overstate (O), understate (U), or not affect (NA) the account. The first item for each error is recorded as an example.
| Error No. 1 | Amount of Error | Effect |
|---|---|---|
| Sales, Year 1 | NA | NA |
| Ending inventory, December 31, Year 1 | ||
| Gross margin, Year 1 | ||
| Beginning inventory, January 1, Year 2 | ||
| Cost of goods sold, Year 1 | ||
| Net income, Year 1 | ||
| Retained earnings, December 31, Year 1 | ||
| Total assets, December 31, Year 1 | ||
| Error No. 2 | Amount of Error | Effect |
| Sales, Year 1 | $1,800 | U |
| Ending inventory, December 31, Year 1 | ||
| Gross margin, Year 1 | ||
| Beginning inventory, January 1, Year 2 | ||
| Cost of goods sold, Year 1 | ||
| Net income, Year 1 | ||
| Retained earnings, December 31, Year 1 | ||
| Total assets, December 31, Year 1 | ||
| Error No. 3 | Amount of Error | Effect |
| Sales, Year 1 | NA | NA |
| Ending inventory, December 31, Year 1 | ||
| Gross margin, Year 1 | ||
| Beginning inventory, January 1, Year 2 | ||
| Cost of goods sold, Year 1 | ||
| Net income, Year 1 | ||
| Retained earnings, December 31, Year 1 | ||
| Total assets, December 31, Year 1 |
Problem 5-25A: Using Ratios to Make Comparisons
The following accounting information pertains to Boardwalk Taffy and Beach Sweets. The only difference between the two companies is that Boardwalk Taffy uses FIFO, while Beach Sweets uses LIFO.
| Item | Boardwalk Taffy | Beach Sweets |
|---|---|---|
| Cash | $120,000 | $120,000 |
| Accounts receivable | $480,000 | $480,000 |
| Merchandise inventory | $350,000 | $300,000 |
| Accounts payable | $360,000 | $360,000 |
| Cost of goods sold | $2,000,000 | $2,050,000 |
| Building | $500,000 | $500,000 |
| Sales | $3,000,000 | $3,000,000 |
Required
a. Compute the gross margin percentage for each company and identify the company that appears to be charging the higher prices in relation to its cost.
b. For each company, compute the inventory turnover ratio and the average days to sell inventory. Identify the company that appears to be incurring the higher financing cost.
c. Explain why a company with the lower gross margin percentage needs to have a higher inventory turnover ratio assuming a period of inflation.
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