Question

Navajo company's year-end financial statements show the following. The company recently discovered that in making physical counts of inventory, it had made the following errors: year 1 ending inventory is understated by 58,000 and year 2 ending inventory is overstated by28,000. For the year ended December 31 year 1 year 2 year 3, prepare a table to show the adjustments necessary to correct the reported amounts. What is the total error in combined net income for the three-year period resulting from the inventory errors?

Answer 1

To correct Navajo Company's errors, adjustments are needed to recalculate the Cost of Goods Sold for each affected year due to an understatement by $58,000 in year 1 and an overstatement by $28,000 in year 2, which alters the net income for those years. These adjustments will ensure that net income is accurately reported over the three-year period. The precise impact on combined net income depends on specific financial statement details not provided.

Step-by-step explanation:

When inventory errors occur, they affect the calculation of Cost of Goods Sold (COGS) and, consequently, the net income of a company. In this case, with the understatement of year 1's ending inventory by $58,000 and the overstatement of year 2's ending inventory by $28,000, adjustments are necessary to correct the reported amounts for a three-year period. The table for adjustments is not provided here due to the lack of specific financial values for the beginning inventory, purchases, and sales for each year mentioned. However, the principle is that an understatement of ending inventory in year 1 would have led to an overstatement of COGS and an understatement of net income for that year. Conversely, the overstatement of ending inventory in year 2 would lead to an understatement of COGS and an overstatement of net income for year 2.

Adjusting for these errors requires recalculating COGS for each year affected. The inventory understatement in year 1 means that COGS for that year was too high and must be decreased by $58,000, which will increase the net income for year 1. The inventory overstatement in year 2 means that COGS for that year was too low and must be increased by $28,000, which will decrease the net income for year 2. For year 3, the beginning inventory will be corrected due to the adjustment in year 2's ending inventory. These adjustments will cumulatively correct the net income reported over the three-year period.

The total error in combined net income can be calculated by adding the net income understated in year 1 and the net income overstated in year 2. As specific financial information is not provided, precise amounts cannot be given without the context of the company's financial statements.