Problem 1 - For each of the following inventory errors occurring during 2018, determine the effect of the error on 2018's cost of goods sold, net income, and retained earnings. Assume that the error is not discovered until 2019 and that a periodic inventory system is used. Ignore income taxes. Use U (understated), O (overstated), or NE (no effect).
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COGS
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Net Income
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Retained Earnings
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Overstatement of ending inventory
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Overstatement of purchases
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Understatement of beginning inventory
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Freight-in charges are understated
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Understatement of ending inventory
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Understatement of purchases
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Overstatement of beginning inventory
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Understatement of purchases plus understatement of ending inventory by the same amount
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Problem 2 - Clothing store Cloak and Dagger uses a periodic inventory system. The company's ending inventory on December 31, 2019, its fiscal-year end, based on a physical count, was determined to be $326,000. Cloak and Dagger's unadjusted trial balance also showed the following account balances: Purchases, $620,000; Accounts payable, $210,000; Accounts receivable, $225,000; Sales revenue, $840,000.
1. Goods valued at $32,000 held on consignment from Threads Count were included in the physical count but not recorded as a purchase.
2. Purchases from Not Too Shabby were incorrectly recorded at $41,000 instead of the correct amount of $14,000. The correct amount was included in the ending inventory.
3. Goods that cost $25,000 were shipped from a vendor on December 28, 2019, terms f.o.b. destination. The merchandise arrived on January 3, 2020. The purchase and related accounts payable were recorded in 2019.
4. One inventory item was incorrectly included in ending inventory as 100 units, instead of the correct amount of 1,000 units. This item cost $40 per unit.
5. The 2018 balance sheet reported inventory of $352,000. The internal auditors discovered that a mathematical error caused this inventory to be understated by $62,000. This amount is considered to be material.
6. Goods shipped to a customer f.o.b. destination on December 25, 2019, were received by the customer on January 4, 2020. The sales price was $40,000 and the merchandise cost $22,000. The sale and corresponding accounts receivable were recorded in 2019.
7. Goods shipped from a vendor f.o.b. shipping point on December 27, 2019, were received on January 3, 2020. The merchandise cost $18,000. The purchase was not recorded until 2020.
Required -
1. Determine the correct amounts for 2019 ending inventory, purchases, accounts payable, sales revenue, and accounts receivable.
2. Calculate cost of goods sold for 2019.
3. Describe the steps Cloak and Dagger would undertake to correct the error in the 2018 ending inventory. What was the effect of the error on 2018 before-tax income?