Question

In 2021, the controller of Sytec Corporation discovered that $62,000 of inventory purchases were incorrectly charged to advertising expense in 2020. In addition, the 2020 year-end inventory count failed to include $40,000 of company merchandise held on consignment by Erin Brothers. Sytec uses a periodic inventory system. Other than the omission of the merchandise on consignment, the year-end inventory count was correct. The amounts of the errors are deemed to be material. Required: 1. Determine the effect of the errors on retained earnings at January 1, 2021. (Ignore income taxes.) 2. Prepare a journal entry to correct the errors.

Answer 1

Reduction is retained earnings by $40,000

The correcting journal entries:

Dr merchandise inventory $40,000

Cr Retained earnings $40,000

Step-by-step explanation:

The impact of the omitted consigned inventory and the inventory purchases debited to advertising expenses are shown below

increase in purchases $62,000

omitted closing inventory ($40,000)

increase in cost of goods sold $22,000

Reduction in advertising expenses $62,000

Increase in retained earnings $40,000

The implication of this is that the closing inventory was lower by $40,000 and retained earning was lower by the same amount

The correcting journal entries:

Dr merchandise inventory $40,000

Cr Retained earnings $40,000

It is noteworthy that a lower closing inventory means a higher cost of goods ,as a result a lower operating profit and retained earnings