Accounting: What the Numbers Mean 9th Edition by Wayne W McManus, Daniel F Viele, David H Marshall

Exercise 5

Effects of inventory errors

a. If the beginning balance of the Inventory account and the cost of items pur­chased or made during the period are correct, but an error resulted in overstat­ing the firm’s ending inventory balance by $5,000, how would the firm’s cost of goods sold be affected? Explain your answer by drawing T-accounts for the Inventory and Cost of Goods Sold accounts and entering amounts that illustrate the difference between correctly stating and overstating the ending inventory balance.

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b. If management wanted to understate profits, would ending inventory be under­stated or overstated? Explain your answer.

Step 1 of 3

Effects – Inventory errors:

a.

Prepare T-Accounts:

The effect of goods sold on the cost due to overstated inventory balance is shown as follows:

Inventory
Particulars	Amount (Dr)	Particulars	Amount (Cr)
Balance is $5,000 and it is too high	$5,000	Credit to correct error	$ 5,000