Question

Inventory errors are self-correcting over two years. Why is this so?

Answer 1

Answer:

Inventory errors are self - correcting over two year.

An inventory error affects two consecutive accounting year, assuming that the errors in the first year is corrected in the second year. An inventory error affect two periods because of that the ending inventory of one period will become the beginning inventory for the period and the calculation of the cost of goods sold is beginning inventory. so that, first accounting year's ending inventory is the second year's beginning inventory.

Inventory errors should result from a counting mistake or incorrect costing of inventory items. Inventory errors come in two forms, overstatements and understatements, which has an effect on the cost of goods sold and net income.

For example :

ART international has beginning inventory in january of $3,00,000 and purchase $6,00,000 of inventory during that month. The staff makes an inventory counting error at the end of january and does not count several items, resulting in an ending inventory of $2,50,000 that is $10,000 too low. ART's accounting staff calculates that the january cost of goods sold is:

$ 3,00,000 beginning inventory + $ 6,00,000 purchase - $ 2,50,000 = $ 6,50,000 cost of goods sold.

If the ending inventory figure has been accurate, the cost of goods sold should have been:

$ 3,00,000 beginning inventory + $ 6,00,000 purchase - $ 2,60,000 ending inventory = $ 6,40,000 cost of goods sold.

Thus, the inventory error results in a cost of goods sold that is too high by $ 10,000, which results in net income before tax that is $ 10,000 too low.

In february, the beginning inventory is still the $ 2,50,000 that was the ending inventory of january. Purchase is $ 6,50,000 during the month. At the end of february, the staff finds the counting error from the preceding month and corrects it. The february ending inventory count is $ 3,10,000 rather than the $ 3,00,000 that would have been the case if the staff had not found the counting error.

ART's accounting staff calculates that the february cost of goods sold must be:

$ 2,60,000 beginning inventory + $ 6,50,000 purchase - $ 3,10,000 ending inventory = $ 6,00,000 cost of goods sold.

If the staff had not found the counting error, then the ending inventory continued to be low by $ 10,000, resulting in an ending inventory $ 3,00,000. the cost of goods sold would then have been:

$ 2,60,000 beginning inventory + $ 6,50,000 purchase - 3,00,000 ending inventory = $ 6,10,000 cost of goods sold.

The error correction in february created a cost of goods sold that was $ 10,000 lower than normal, which results in net income before taxes that is too high by $ 10,000.

Thus, the inventory errors an incorrect net income figure in the first month, when the correction of that error in the second month creates an offsetting adjustment to the net income figure in the second month.

So that, inventory errors are self correcting over two year, because the ending inventory of one year is the beginning inventory of the next year.