[accounting] A retailer completed a physical count of ending merchandise inventory. When counting inventory, employees did not include $2,200 of incoming goods shipped by a supplier on December 31 under FOB shipping point. These goods had been recorded in Merchandise Inventory, but they were not included in the physical count because they were in transit. This means shrinkage was incorrectly overstated by $2,200.

Compute the amount of overstatement or understatement for each of the following amounts for this period.

a. ending inventory
b. total assets
c. net income
d. total equity

Answer:

a. Ending inventory  - UNDERSTATED by $2,200

The goods were shipped FOB shipping point which means that they should be included as inventory as soon as they are shipped by the supplier. As they were not, Inventory was understated by $2,200.

b. Total assets  - UNDERSTATED by $2,200

Inventory is part of Assets so if Inventory is understated by $2,200  then so are Total Assets.

c. Net income  - UNDERSTATED by $2,200

Ending Inventory is subtracted from Cost of Goods sold which is then subtracted from Revenue. As ending inventory was understated, that means Cost of Goods sold was Overstated and therefore had the effect of understating Revenue and by extension, Net Income.

d. Total equity - UNDERSTATED by $2,200

Net Income goes to Total equity as Retained earnings so if Net income is understated so also is Total equity.

The amount of understatement for ending inventory, total assets, net income, and total equity is $2200.

From the information given, the amount of overstatement or understatement for each amount for this period will be:

When inventory is understated, the assets will be understated too. Also, when net income is understated, total equity is understated too.

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[The following information applies to the questions displayed below.]
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Debit Credit
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Accounts Receivable 2,000
Prepaid Insurance 2,300
Notes Receivable (long-term) 3,000
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Insurance Expense 1,400
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Income Tax Expense 2,900
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