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 $60,000 and Year 2 ending inventory is overstated by $30,000.

For Year Ended December 31Year 1Year 2Year 3(a)Cost of goods sold$735,000$965,000$800,000(b)Net income 278,000 285,000 260,000(c)Total current assets 1,257,000 1,370,000 1,240,000(d)Total equity 1,397,000 1,590,000 1,255,000
Required:
1. For each key financial statement figure—(a), (b), (c), and (d) above—prepare table to show the adjustments necessary to correct the reported amounts.
2. What is the total error in combined net income for the three-year period resulting from the inventory errors?

Answer 1

The adjustments necessary to correct reported financial amounts include increasing Year 1 Cost of Goods Sold by $60,000 and decreasing Year 2 Cost of Goods Sold by $30,000. Net Income should be decreased by $60,000 in Year 1 and increased by $30,000 in Year 2. The total error in combined net income for the three-year period is $30,000.

Step-by-step explanation:

Adjustments to Financial Statement Figures:

(a) Cost of Goods Sold:

• Year 1: Increase by $60,000
• Year 2: Decrease by $30,000

(b) Net Income:

• Year 1: Decrease by $60,000
• Year 2: Increase by $30,000

(c) Total Current Assets: No adjustment needed

(d) Total Equity: No adjustment needed

Total Error in Net Income:

The total error in combined net income for the three-year period resulting from the inventory errors is $30,000.