Here is a question that may be very easy, but I can’t seem to wrap my head around it… At the end of 2003 FIFO inventory was overstated by $10,000 and the error was corrected at the end of 2004. The effect of the misstatement is to: A. increase NI in 2003, increase COGS in 2004. B. decrease NI in 2003, decrease COGS in 2004. C. decrease NI in 2003, increase COGS in 2004. D. increase NI in 2003, decrease COGS in 2004.
Here’s a shot at it… A. increase NI in 2003, increase COGS in 2004. 2003 Ending inventory was overstated, so COGS was understated & net income was overstated. 2004 Beginning inventory was overstated, so COGS was overstated.
I agree with snob! I just don’t understand why FIFO was mentioned.
i agree, i also don’t understand why FIFO was mentionned
FIFO is the key actually, think about it BI + P = EI + COGS P is fixed, no matter what, so that leaves only BI, EI, and COGS as possible candidates that can be affected by accounting method for 2003, you can conclude COGS is lower -> NI higher because you were told EI was higher (given no information about BI, so you have to assume it’s ok), this would be regardless of the accounting method but for 2004, BI is higher, but is EI higher or COGS higher? to determine this, this is where the accounting method comes in, had it been LIFO that they use, EI would be higher, and COGS would be ok (assume no LIFO liquidation)
liaaba Wrote: ------------------------------------------------------- > but for 2004, BI is higher, but is EI higher or > COGS higher? to determine this, this is where the > accounting method comes in, had it been LIFO that > they use, EI would be higher, and COGS would be ok > (assume no LIFO liquidation) The inventory method really is pretty much irrelevant for the question as stated. They tell you “the error was corrected at the end of 2004”. This means EI was shown correctly at the end of 2004. There is no as you said “is EI higher” issue , and thus the error was corrected by running it through the income statement, in CGS.
FIFO, LIFO, Average Cost…what’s it matter? If Inventory was overstated, Inventory was overstated regardless of costing method. Which also means COGS was understated regardless of costing method, which also means Net Income was overstated regardless of costing method. FIFO is thrown in there to get you chasing your tail, which I hear CFA exam questions are prone to do. Just need to learn to put on your noise filter and see the important datapoints. A is correct. If inventory was overstated in 2003, then COGS was understated, and Net Income was overstated. If the problem was corrected in 2004, then COGS will be overstated in 2004.
Super I… this kind of error is run through the current year P&L? Or, is it an adjustment to RE? Given your response, sounds like the additional COGS expense would be taken in 04
apcarlso Wrote: ------------------------------------------------------- > Super I… this kind of error is run through the > current year P&L? Or, is it an adjustment to RE? > > Given your response, sounds like the additional > COGS expense would be taken in 04 You run it through the P&L in current year’s CGS (common), unless its material enough to require restatement of previously reported financials (rare).
If feel like I understand inventory methods pretty well, but the way this question was stated made the concept a little convoluted. Should questions like this be expected on the exam?
ttouchst…I’m quite sure that we could expect questions like this in the exam. The concept is fairly straightforward if you filter out the unnecessary info. given in the question. End Inv Overstated -> Less COGS -> Higher NI End Inv Understated -> High COGS - > Low NI
Thanks kevin002, you’re right, when you put it that way it is much easier. For some reason I was getting hung up on fifo and it didn’t have any relevance to the question.