Inventory Errors & Adjustments
Concept Check
Inventory errors affect only the balance sheet
➛ False
They affect both the Income Statement (COGS, profit) and the Balance Sheet (inventory, retained earnings)
Overstated ending inventory results in overstated profit
➛ True
➧ Overstated ending inventory
➧ understated COGS
➧ overstated profit.
Understated beginning inventory increases profit
➛ True
➧ Understated beginning inventory
➧ understated COGS
➧ overstated profit.
Inventory errors can affect two accounting periods
➛ True
Errors in one period reverse in the next period.
Identify the Effect
State the effect on COGS and Profit
1. Ending inventory overstated
Effect on COGS
Understated
Understated
Effect on Profit
Overstated
Overstated
Effect on COGS
Overstated
Overstated
Effect on Profit
Understated
Understated
Effect on COGS
Overstated
Overstated
Effect on Profit
Understated
Understated
Effect on COGS
Understated
Understated
Effect on Profit
Overstated
Overstated
Error Analysis
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
Type of Error
Ending inventory overstated by $5,000
Effect on COGS
COGS is understated by $5,000
Effect on Profit
Profit is overstated by $5,000
Journal Entry Practice
Ending inventory was understated by $3,000.
Prepare the correcting journal entry.
Inventory
Cost of Goods Sold
Cost of Goods Sold
Dr 3,000
Cr 3,000
Cr 3,000
Mini Case Study
A business discovers that last year’s inventory count included damaged goods that should not have been counted.
Questions
Was inventory overstated or understated?
➛ Overstated
How did this affect last year’s COGS?
➛ COGS was understated
How did it affect profit?
➛ Profit was overstated
Why are physical counts important?
➛ Detect errors and damaged/obsolete goods
➛ Ensure inventory records match reality
➛ Prevent fraud and misstatements
➛ Improve accuracy of financial statements
Quick Quiz
What is an inventory error?
➛ An incorrect recording or valuation of inventory quantities or amounts.
How does overstated ending inventory affect profit?
➛ It overstates profit.
Which inventory error causes overstated COGS?
➛ Understated ending inventory or overstated beginning inventory.
Can inventory errors affect more than one period?
➛ Yes, they affect the current period and reverse in the next period.
Name one way to prevent inventory errors.
➛ Regular physical counts, proper internal controls, staff training, or inventory management systems.
Inventory Control & Internal Controls ➧ Here