Question

Problem A The Rodgers Company discovered that its inventory was overstated by $750,000 after it had published its 2013 annual report. The company reported net income of $10,000,000 on its 2013 income statement and had a tax rate of 20%. Assume tax expense has been recorded but not yet paid. 1. What specific accounts and amounts are impacted by this error? 2. When the company corrects this error and republishes its income statement, what will be the corrected net income?

Answer 1

Hi,

So to begin with, there has been an error by the company that it has overvalued its inventory by 750,000$.

1) This error has an impact on a) the Stock account, as it is wrongly overstated and misreported in the financial statements by 750,000$ and b) on the profit and loss as the profit is overstated by 750,000$ and the actual net income is not 10,000,000$ but 9,400,000$ (calculated by first calculating before tax income i.e. 10,000,000/20%, reinstating the correct profit by giving effect of 750,000$, and lastly calculating tax on remaining profit.)

2) The corrected net income is 9,400,000$ calculated in the following manner.

Old Income (After tax) - 10,000,000$,

Old Income (Before Tax) - 12,500,000$ (10,000,000$/20%)

Effect of overstated inventory - (750,000$)

New Income (Before Tax) - 11,750,000$

Tax on new income - 235,000$

New Income (After tax) - 9,400,000$