Inventory errors: Beginning and Ending Inventory and Income statement correction
The errors in recording inventories give the correct reason. Sometimes it is overstated on profit and sometimes it understates on profit. Actually, the mistake in recording the beginning inventory and closing inventory is called inventory errors.
The beginning inventory like an expense, when it is overstated the profit is understated. Similarly, when beginning inventory understated the profit is overstated. The closing inventory like an asset, income, when the ending inventory overstated it is overstated the profit and when ending inventory understated it is understated the profit. Hence, inventory errors effect on net profit or income of a business firm as either increases or decreases.
Example of Inventory errors
Following is the summary income statement of M/S Nepal Trading for two years period.
| Particulars | 2017 | 2018 |
| Sales Cost of goods sold: Beginning inventory Add: Purchases | 2,00,000 25,000 1,80,000 | 3,00,000 50,000 2,45,000 |
| Cost of goods available for sales Less: Ending inventory Cost of goods sold | 2,05,000 50,000 1,55,000 | 2,95,000 45,000 2,50,000 |
| Gross profit Operating expenses | 45,000 20,000 | 50,000 35,000 |
| Net income | 25,000 | 15,000 |
On investigation of the company’s records, it was found that the ending inventory for the year 2017 was overvalued or overstated by Rs. 10,000.
Required: Prepare the correct income statement.
Solution:
M/S Nepal Trading
Corrected Income Statement
| Particulars | 2017 | 2018 |
| Sales Cost of goods sold: Beginning inventory Add: Purchase | 2,00,000 25,000 1,80,000 | 3,00,000 40,000 2,45,000 |
| Cost of goods available for sales Less: Ending inventory Cost of goods sold | 2,05,000 40,000 1,65,000 | 2,85,000 45,000 2,40,000 |
| Gross profit Operating expenses | 35,000 20,000 | 60,000 35,000 |
| Net profit or income | Rs. 15,000 | Rs. 25,000 |
Further, Suppose that on the investigation of the company’s records it was found that the beginning inventory for the year 2017 was overvalued or overstated by Rs. 10,000. Prepare the corrected income statement.
Solution:
M/S Nepal Trading
Corrected Income Statement
| Particulars | 2017 | 2018 |
| Sales Cost of goods sold: Beginning inventory Add: Purchases | 2,00,000 15,000 1,80,000 | 3,00,000 50,000 2,45,000 |
| Cost of goods available for sales Less: Ending inventory Cost of goods sold | 1,95,000 50,000 1,45,000 | 2,95,000 45,000 2,50,000 |
| Gross profit Operating expenses | 55,000 20,000 | 50,000 35,000 |
| Net profit | Rs, 35,000 | Rs. 15,000 |
Again, suppose that on the investigation of the company’s records it was found that the beginning inventory and ending inventory for the year 2017 was undervalued or understated by Rs. 10,000. Prepare the corrected income statement.
M/S Nepal Trading
Corrected Income Statement
| Particulars | 2017 | 2018 |
| Sales Cost of goods sold: Beginning inventory Add: Purchases | 2,00,000 35,000 1,80,000 | 3,00,000 60,000 2,45,000 |
| Cost of goods available for sales Less: Ending inventory Cost of goods sold | 2,15,000 60,000 1,55,000 | 3,05,000 45,000 2,60,000 |
| Gross profit Operating expenses | 45,000 20,000 | 40,000 35,000 |
| Net income | Rs. 25,000 | Rs. 5,000 |