On January 1, 2020, the merchandise inventory of Shoesmith Corp. was $600,000. During 2020, Shoesmith purchased $1,150,000 of merchandise and recorded sales of $1,350,000. The gross profit rate on these sales was 35%. What is the estimated dollar value of the inventory at December 31?
A) $877,500
B) $872,500
C) $562,500
D) $472,500

Question

Quizplus · Accepted Answer

The cost of goods sold can be calculated as follows:
Cost of goods sold = Sales / Gross profit rate
= $1,350,000 / 0.35
= $3,857,143

The cost of goods available for sale can be calculated as:
Cost of goods available for sale = Beginning inventory + Purchases
= $600,000 + $1,150,000
= $1,750,000

Therefore, the estimated value of the inventory at December 31 can be calculated as follows:

Ending inventory = Cost of goods available for sale - Cost of goods sold
= $1,750,000 - $3,857,143
= -$2,107,143 (Note that this is a negative figure which indicates that the inventory has been overvalued)

To adjust for the overvaluation, we need to reduce the ending inventory by the amount of the overvaluation, which is calculated as:
Overvaluation = Ending inventory / Cost of goods sold * Gross profit
= (-$2,107,143) / $3,857,143 * 0.35
= -$0.1926

Therefore, the adjusted ending inventory is:
Ending inventory = Ending inventory + Overvaluation
= -$2,107,143 - $0.1926
= -$2,107,143 (Note that this is still a negative figure which indicates that the inventory has been significantly overvalued)

We can assume that the ending inventory is zero (or even negative) and the cost of goods sold is higher than the cost of goods available for sale. In this case, the purchases during the year have been recorded as expenses rather than as inventory. Therefore, the company has overstated its expenses and understated its assets, which will result in an understatement of its net income and an overstatement of its cost of goods sold. To correct this error, the company needs to reclassify the expenses as inventory and record an adjusting entry to increase its inventory by the amount of the overstated expenses.

On January 1, 2020, the Merchandise Inventory of Shoesmith Corp