Look at ‘Changes’ Created by
Using Correct Ending Inventory
As Reported
Year 1 Year 2
10
As Corrected
Year 1 Year 2
10
Sales
C of GS:
Begin. Inv.
+Purchases
Gds. Avail.
- Ending Inv.
=C of G. Sold Exp
1
7
8
2
6
1
7
8
3
5
Gross Margin
4
5
What about Balance Sheet at end of Year 1?
Sales
C of GS:
Begin. Inv.
+Purchases
Gds. Avail.
- Ending Inv.
=C of G. Sold
Gross Margin
As Reported
Year 1 Year 2
10
11
As Corrected
Year 1 Year 2
10
1
7
8
2
6
2
8
10
4
6
1
7
8
3
5
4
5
5
Sales
C of GS:
Begin. Inv.
+Purchases
Gds. Avail.
- Ending Inv.
=C of G. Sold
Gross Margin
As Reported
Year 1 Year 2
10
11
As Corrected
Year 1 Year 2
10
11
1
7
8
2
6
2
8
10
4
6
1
7
8
3
5
3
8
11
4
7
4
5
5
4
What about Balance Sheet at end of Year 2?
What was the effect of
understating the Year 1 ending
inventory by $1? (ignore taxes)
Year 1
Sales
Begin. Inventory
+Purchases
=Goods Avail. for Sale
-Ending Inventory
=Cost of Goods Sold
Gross Profit Margin
Net Income
Ret. Earn, end. Bal.
Year 2
What was the effect of
understating the Year 1 ending
inventory by $1? (ignore taxes)
Year 1
Year 2
Sales
Begin. Inventory
+Purchases
=Goods Avail. for Sale
-Ending Inventory
=Cost of Goods Sold
Gross Profit Margin
Net Income
Ret. Earn, end. Bal.
Compare the Reported
amounts for each year with
the Corrected amounts.
What was the effect of
understating the Year 1 ending
inventory by $1? (ignore taxes)
Year 1
Sales
No effect
Begin. Inventory
No effect
+Purchases
No effect
=Goods Avail. for SaleNo effect
Understated $1
-Ending Inventory
=Cost of Goods Sold Overstated $1
Gross Profit Margin Understated $1
Net Income
Understated $1
Ret. Earn, end. Bal.
Understated $1
Year 2
What was the effect of
understating the Year 1 ending
inventory by $1? (ignore taxes)
Year 1
Year 2
Sales
No effect
No effect
Begin. Inventory
No effect
Understated $1
Purchases
No effect
No effect
Understated $1
Goods Avail. for Sale No effect
Understated $1 No effect
Ending Inventory
Cost of Goods Sold
Overstated $1
Understated $1
Gross Profit Margin
Understated $1 Overstated $1
Net Income
Understated $1 Overstated $1
Ret. Earn, end. Bal.
Understated $1 No effect (why?)
Does Bal. Sheet Balance? Does Bal. Sheet Balance?
Ex: In Yr. 3 we find that Yr. 1 ending inv. was
understated by $1.
As Reported
Year 1 Year 2
Sales
10
C of GS:
Begin. Inv.
1
+Purchases
7
Gds. Avail.
8
- Ending Inv.
2
=C of G. Sold
6
Gross Margin
As Corrected
Year 1
Year 2
4
What was the effect of the error on the Yr. 1 and Yr. 2 Statements?
Inventory Ratio--Avg. Number of Days
Supply of Inventory on Hand
(Do NOT follow method used on page 281 in
Textbook)
How long will your inventory supply last before you run out?
(How many days go by between the time inventory arrives and when it is
sold to a customer?)
Average Number of Days
=
Inventory_____________
Supply of Inventory on Hand
Average Daily Cost of Goods Sold
(Cost of Goods Sold Expense for Year /365 Days)
Inventory Ratio--Avg. Number of
Days Supply of Inventory on Hand
An Example
Inventory
Average Daily Cost of Goods Sold
(Cost of Goods Sold Expense for Year / 365 Days)
$5,000 Inventory
$82.19 Average Daily Cost of Goods Sold
($30,000 CofGS/365 days)
Answer = 60.8 Days Supply of Inventory on
Hand
Cost of carrying too much inventory vs. cost of not carrying
enough inventory!
Inventory “Turnover” Ratio
Inventory “Turnover” =
_______365 Days__________
60.8 Days Inv. on Hand
Inventory “Turnover” = 6 times
Which is more “understandable”:
1.) You have 61 days supply of inventory on hand ?
2.) Your inventory “turned over” 6 times ?
Class Assignment Questions
Questions 1, 5, 6, 12, 15 (Page 289 in
textbook)
Chapter 6
The End