Question

Armstrong Inc. is a calendar-year corporation. Its financial statements for the years ended 12/31/12 and 12/31/13 contained the following errors:

2012 2013
Ending inventory $20,000 overstatement $32,000 understatement
Depreciation expense 8,000 understatement 16,000 overstatement

Assume that the 2012 errors were not corrected and that no errors occurred in 2011. By what amount will 2012 income before income taxes be overstated or understated?
a. $28,000 overstatement
b. $12,000 overstatement
c. $28,000 understatement
d. $12,000 understatement

Answer 1

Armstrong Inc.'s 2012 income before taxes is overstated by $28,000 due to a $20,000 overstatement of ending inventory and an $8,000 understatement of depreciation expense.

Step-by-step explanation:

To determine the impact of the errors on Armstrong Inc.'s 2012 income before taxes, we need to analyze how overstatement and understatement of ending inventory and depreciation expense affect the accounting records. The overstatement of ending inventory by $20,000 will cause the cost of goods sold (COGS) to be understated, leading to an overstatement of income. Conversely, an understatement of depreciation expense by $8,000 will cause expenses to be understated, leading to an overstatement of income as well.

Therefore, the combined effect of these errors on the 2012 income before taxes is an overstatement of $20,000 (due to inventory overstatement) plus $8,000 (due to understatement of depreciation expense), which results in a total overstatement of $28,000.

The correct answer to the question is:

• a. $28,000 overstatement