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タグ:Retained Earnings ( 1 ) タグの人気記事

Error Correction regarding Error Correction!

On Aug.17, 2007, I gave my idea about the questions given on the CPA net. I gave a second thought about my response regarding question#1, and corrected my idea in the following way.

The question was,

"The physical inventory count on Dec 31, 01, improperly excluded merchandise costing $39,000 that had been temporarily stored in a public warehouse. The company uses a periodic inventory system. How should we make an adjustment to the journal entry."

Now, in my opinion, the AJE should be

(Dr.) CGS 39,000 / RE 39,000 (Cr.)

Following are my reasoning.

1. Why should we debit RE by $39,000?
a0050593_12551546.gif

Understated Ending Inventory of FY2001 results in the overstated CGS of FY2001, which leads to the understated Net Income of FY2001. The amount of Net Income of a period is accumulated at the equity part and is carried over to the next period. Thus, the understated Net Income of FY2001 leads to the understated R/E of the next period.
In this case, R/E of FY2002 is understated by $39,000, and you have to make an adjustment by crediting (increasing) R/E of FY2002 by $39,000.

2. Why should we debit CGS by $39,000?
a0050593_12553476.gif

Understated Ending Inventory of FY2001 results in the understated CGS of FY2002, on the condition that Ending Inventory of FY2002 was counted correctly. For adjustment, you have to increase CGS of FY2002 by debiting $39,000 CGS.

By the way, my idea above is still conditional!
It could have two other variations depending on the condition given in the situation of the question.

1) When the error was found before tne year end inventory counting, it should be as follows.

(Dr.) Inventory 39,000 / RE 39,000 (Cr.)

In my previous post, I wrote "on the condition that Ending Inventory of FY2002 was counted correctly." If the year end inventory counting was not conducted at this point and the amount of EI was not fixed yet, then we should increase the amount of Beginning Inventory of FY2002.


2) If the tax rate is given in the question, the adjustment of R/E should be net of tax. Say, if the tax rate was 40%, then it should be:

(Dr.) Inventory 39,000 / RE 23,400 (Cr.)
             / Taxes Payable 15,600 (Cr.)

Adjustment of the RE is done to adjust the effects from the previous year's incorrect Net Income, which was the result of calculation after deducting tax expenses of the period. The effect of over/understatements of some accounts affects both Net Income and Tax Expense of the period, which should be adjusted by restating R/E and Tax payable of the following periods.

Above correction was added to the CPA-NET article in question.
If my idea above still has some flaw, there will appear some arguments again. Let's see.
[PR]
by nn_77 | 2007-09-03 12:53 | >FARE


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