Inventory Errors & Adjustments

Module 4:
Inventory & Costing

Duration:
45-60 minutes

Level:
Beginner to Diploma-Level

➛ Define inventory errors

➛ Identify common types of inventory errors

➛ Understand how inventory errors affect COGS

➛ Analyze the impact of inventory errors on profit and financial statements

➛ Correct inventory errors using adjustments

➛ Explain the importance of inventory control and internal checks

➛ Inventory Error
➛ Beginning Inventory
➛ Ending Inventory
➛ Cost of Goods Sold
➛ Overstatement
➛ Understatement
➛ Adjustment
➛ Physical Count

Inventory errors occur when

➛ Inventory quantities or values are recorded incorrectly
➛ Physical count does not match accounting records
➛ Errors happen during recording, counting, or valuation

Inventory errors directly affect COGS, profit, and financial statements.

1. Ending Inventory Errors

Overstated Ending Inventory
➛ COGS is understated
➛ Profit is overstated

Understated Ending Inventory
➛ COGS is overstated
➛ Profit is understated

2. Beginning Inventory Errors

Overstated Beginning Inventory
➛ COGS is overstated
➛ Profit is understated

Understated Beginning Inventory
➛ COGS is understated
➛ Profit is overstated

General Rule
➛ Inventory errors are corrected in the next accounting period
➛ Adjustment is made through retained earnings if prior periods are affected

Small errors may be corrected through COGS.

Ending inventory was overstated by $5,000.

Correction Entry

Income Statement
➛ Incorrect COGS
➛ Incorrect gross profit and net income

Balance Sheet
➛ Inventory misstated
➛ Retained earnings misstated

Answer True or False

➛ Inventory errors affect only the balance sheet

➛ Overstated ending inventory results in overstated profit

➛ Understated beginning inventory increases profit

➛ Inventory errors can affect two accounting periods

State the effect on COGS and Profit

➛ Ending inventory overstated
➛ Ending inventory understated
➛ Beginning inventory overstated
➛ Beginning inventory understated

A company reported

Ending Inventory = $40,000
Actual Ending Inventory = $35,000

Tasks
➛ Identify the error
➛ State the effect on COGS
➛ State the effect on profit

Ending inventory was understated by $3,000.

Prepare the correcting journal entry.

A business discovers that last year’s inventory count included damaged goods that should not have been counted.

Questions

➛ Was inventory overstated or understated?

➛ How did this affect last year’s COGS?

➛ How did it affect profit?

➛ Why are physical counts important?

➛ What is an inventory error?

➛ How does overstated ending inventory affect profit?

➛ Which inventory error causes overstated COGS?

➛ Can inventory errors affect more than one period?

➛ Name one way to prevent inventory errors.

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Answers ➧ Here

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Inventory Control & Internal Controls ➧ Here