# One more inventory question

From a previous BSAS exam: Use the following information for questions 11 through 13. Patriot Inc is a calendar year corporation. Its financial statements for the years Year 2 and Year 1 contained errors as follows: Year 1 Ending inventory \$6,000 overstated Depreciation expense \$4,000 overstated Year 2 Ending inventory \$2,000 overstated Depreciation expense \$1,600 understated 11. Assume that the proper correcting entries were made at December 31, Year 1. By how much will Year 2 income before taxes be overstated or understated? A. \$400 understated. B. \$400 overstated. C. \$1,600 overstated. D. \$3,600 overstated. 12. Assume that no correcting entries were made at December 31, Year 1. Ignoring income taxes, by how much will retained earnings at December 31, Year 2 be overstated or understated? A. \$400 understated. B. \$3,600 overstated. C. \$3,600 understated. D. \$6,400 understated. 13. Assuming that no correcting entries were made at December 31, Year 1 or December 31, Year 2 and that no additional errors occurred in Year 3. Ignoring income taxes, by how much will working capital at December 31, Year 3 be overstated or understated. A. \$0. B. \$2,000 overstated. C. \$2,000 understated. D. \$3,600 understated.

11 D

Yes 11 was easy and the answer is D. But it is 12 and 13 that gave me a spin and I could not answer it correctly. Correct answers are : 11-D, 12-A and 13-A

i am getting 5600 for 12… 2000 from first yr and 3600 from the second

As stated, the correct answer to 11 is D, For 12: The effect of the 2 depreciation errors is that cumulatively expense is overstated by a net \$2,400. Inventory errors self correct on a cumulative basis from year to year. Remember the formula: Beginning inventory + Purchases -ending inventory =CGS One year’s ending inventory is the next years beginning so a signle year error will correct in the next, which means at year 2 all we have is a \$2,000 EI overstatement, which cause a CGS (expense) understatement of \$2,000. The net of these two items (depreciation and CGS) is a \$400 expense overstatement, or a \$400 RE understatement, for Answer A. For 13: Depreciation is not working capital, so no effect there. As for the inventory errors, as I said they self correct thru RE in the next year, and at the end of year 3 (NOT year 2) if there are no errors and ending inventory was properly counted, as given in the problem, there is no working capital effect, giving us Answer A

I forgot about the self correcting nature of inventory changes from year to year. That is where I was making the mistake. Thanks for the response. I got 13 right later so I did not have an issue with it.

CAn you explain the self correcting nature of inventory. I did not get taht bit

Beginning inventory + Purchases -ending inventory1 =CGS 1 beg inventory2+purchases - ending inventory2=CGS2 but ending inventory1= beg inventory 2 .if we want to see the overall change in the 2 years cgs1+cgs2= beg inventory -ending inventory1+beg inventory2(end inventory1)-ending inventory2 = beg inventory1-ending inventory2 Therefore if you take the cumulative error of the 2 years- the only error will be the error at the end of year 2 because the inventory self corrects -That is if in one year you everstate it in the next you will understate it, so the result will be 0 if no other problems occur I had problems with this too so tell me if i’m wrong