To practice correcting the financial statements for an inventory calculation error. (See Topic Guides A 13,...

  

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To practice correcting the financial statements for an inventory calculation error. (See Topic Guides A 13, 14, 37, 38). Information: Burkett's management is afraid that an error was made when calculating COGS. Most of the calculations have already been checked by the auditors, but management still thinks that one inventory item has not been correctly recorded. They would like you to go back through the inventory calculations for that item to correct any possible mistakes. Currently they show that 9,600 units of item TC178, purchased for $9 each, were on hand at the beginning of the year, that $817,000 worth of TC178 was purchased during the year, that discounts of $7,600 were earned by making early payments on these purchases, and that $6,800 worth of returns were made during the year. The records show that only 8,600 units of the beginning TC178 inventory remained at the end of the year. Burkett uses the perpetual LIFO system for calculating inventory. Their inventory transactions for item TC178 for the period are as follows: (NOTE that the vendor provides free shipping on all units of TC178) . At the beginning of the period, 9,600 units of TC178, purchased for $9.00 each, were on hand. . On Jan 15, an additional 29,000 units were purchased for $10.00 each. . On February 28, 26,000 units were sold. . On March 14, an additional 15,000 units were purchased for $12.00 each. . On March 20, a 3.0% cash discount was earned by paying for the March 14 purchase early. . On March 30, 17,000 units were sold. . On July 30, 5,800 units were sold. . On August 20, an additional 26,000 units were purchased for $15.00 each. • On September 2, 12,000 units were sold. . On December 1, 10,400 units were sold. Burkett's management would like to know the effect of the sale on the following ratios: • Inventory Turnover (COGS/ average total inventory) . Current Ratio . ROA Assignment: Calculations 1. Calculate each of the three (3) ratios before you make any adjustments. 2. Make the appropriate journal entries, if any, to correct the reported values of item TC178 (including any necessary changes to income tax expense). 3. Make any necessary changes to the financial statements. 4. Calculate the three (3) ratios after you make any adjustments. Critical Thinking 5. What do you think the investors' reaction will be to the adjustment of inventory? In other words, based on your changes to the financial statements and the change in the ratios, do you think investors will be happy with the restatement? Why or why not? Hints: 6. Who might be affected if the management team decided not to correct this error? Burkett's COO has repeatedly argued that no adjustment should be made to the current numbers. After all, she suggested, everything would be sold in the next period anyway. Why worry investors over something that is so unimportant? Defend your answer. 1. Start out by calculating Burkett's COGS on TC178 given the original information. The best way to do this is to set up a formal COGS calculation like the one we did in the Income Statement in Burkett #2. The formal calculation for one product would look just like the COGS section of the income statement, but it would only include the values for the one product. 2. Use the perpetual inventory method to find out what purchases, purchase discounts, and COGS should be for TC178 using a formal perpetual inventory table. Once you have those numbers, set up another formal COGS calculation like the one you made for the original information using the new information. 3. Compare the new COGS calculation to the old one. The differences between the two sets of calculations are the changes that you need to record in your journal entry. 4. When making your journal entry, keep in mind that Burkett has a perpetual inventory system. This means the company doesn't have a 'purchase returns' or a 'purchase discount' account. Instead, everything will be done using the inventory account. Your final entry, then, should change only three accounts: COGS, Inventory, and A/P. You can get the changes to COGS and Inventory from the differences in your COGS equations (old vs. new). You will use A/P as the plug figure. Why? Well, to explain that, we have to go back to what the original journal entries look like for a company that uses the perpetual inventory system. When we buy inventory in a perpetual system, we debit inventory and credit A/P. When we pay for inventory, we debit A/P and credit cash. If we get a discount or make a return, we debit A/P and credit Inventory. That means that any mistake in recording purchases, returns, or discounts would cause a mistake in both the Inventory account AND the A/P account. When we sell inventory, we would debit COGS and credit Inventory, so mistakes in recording sales would cause a mistake in both Inventory AND COGS. So, in order to correct for all of Burkett's mistakes, we need to adjust all three of those accounts: Inventory, COGS, and A/P. Sales Revenue Sales Revenue Less: Sales Discounts Sales Returns Terry Co. Multi-Step Income Statement For the Year Ended December 31, Year 2 Net Sales Revenue Cost of Goods Sold Gross Profit Cost of Goods Sold Operating Activities Selling Expenses Advertising Expense Miscellaneous Selling Expenses Sales Force Salaries Expense Selling Commissions Expense Shipping Expense Administrative Expenses Executive Salaries Expense Depreciation Expense Insurance Expense Miscellaneous Admin. Expenses Office Supplies Expense Consulting and Legal Fees Utilities Expense Total Administrative Expenses Income from Operations EPS $423,750 $110,175 $310,750 $1,130,000 $185,038 $988,750 $1,356,000 $194,925 $11,159 $87,575 $14,125 $169,500 Other Gains and Losses Rent Revenue Interest Expense Income from Continuing Operations before Taxes Income Tax Expense Net Income $271,200 ####林林林 $2,159,713 $2,822,034 $70,625 ($144,075) ######## $1,344,700 $21,255,300 $12,370,308 $8,884,992 $4,981,747 $3,903,245 ($73,450) $3,829,795 ($1,148,939) $2,680,856 $1.03 Current Assets Cash A/R Total Assets Allowance for Bad Debts Inventory Prepaid Insurance Prepaid Rent Total Current Assets Long-term Investments Loans to other businesses Expansion Fund Total Long-term Investments PPE Land Building Equipment Accumulated Depreciation Total PPE Intangible Assets Patents, net Current Liabilities Terry Co. Balance Sheet As of 12/31/Year 2 Accounts Payable Income Tax Payable Unearned Revenue Long-term Debt Assets Wages Payable Current Portion of Loan Payable Total Current Liabilities Loan Payable Notes Payable Liabilities and Stockholders' Equity $391,944 $395,500 $565,000 Total Long-term Debt Year 2 $1,026,000 $1,130,000 $2,034,000 $1,921,000 ($113,000) ($565,000) $2,712,000 $3,164,000 $349,500 $339,000 $282,500 $226,000 $6,291,000 $6,215,000 Retained Earnings Total Stockholders' Equity $904,000 $904,000 $678,000 $678,000 $1,582,000 $1,582,000 $2,486,000 $1,582,000 $1,808,000 $1,808,000 $6,328,000 $2,938,000 ($3,616,000) ($2,260,000) $7,006,000 $4,068,000 $339,000 $15,218,000 $271,200 $113,000 $1,736,644 $565,000 $3,164,000 Year 1 $3,729,000 $5,465,644 Total Liabilities Stockholders' Equity Common Stock ($1 par, 5,000,000 authorized, 2,600,000 outstanding) Additional Paid-In Capital $678,000 $6,474,356 $9,752,356 Total Liabilities and Stockholder $15,218,000 $339,000 $12,204,000 $1,356,000 $226,000 $339,000 $282,500 $113,000 $2,316,500 $678,000 $1,808,000 $2,486,000 $4,802,500 $2,600,000 $2,600,000 $678,000 $4,123,500 $7,401,500 $12,204,000 Terry Co. Statement of Cash Flows For Year Ended 12/31/Year 2 Cash Flow from Operations Net Income Adjustments: Change in A/R Change in Inventory Change in Prepaid Insurance Change in Prepaid Rent Depreciation & Amortization Change in A/P Change in Income Tax Payable Change in Unearned Revenue Change in Wages Payable Net Cash Flow from Operations Cash Flow from Investments Purchase of Land Purchase of Equipment Net Cash Flow from Investments Cash Flow from Financing Repayment of Loans Issuance of Notes Payable Payments of Dividends Net Cash Flow from Financing Net Increase (Decrease) in Cash Cash, January 1, Year 2 Cash, December 31, Year 2 ($565,000) $452,000 ($10,500) ($56,500) $1,356,000 ($964,056) $169,500 $226,000 ($11,300) ($904,000) ($3,390,000) ($113,000) $1,356,000 ($330,000) $2,680,856 $596,144 $3,277,000 ($4,294,000) $913,000 ($104,000) $1,130,000 $1,026,000 Financial Ratios Before Critical Thinking #1 Critical Thinking #2 After Final Journal Entries To practice correcting the financial statements for an inventory calculation error. (See Topic Guides A 13, 14, 37, 38). Information: Burkett's management is afraid that an error was made when calculating COGS. Most of the calculations have already been checked by the auditors, but management still thinks that one inventory item has not been correctly recorded. They would like you to go back through the inventory calculations for that item to correct any possible mistakes. Currently they show that 9,600 units of item TC178, purchased for $9 each, were on hand at the beginning of the year, that $817,000 worth of TC178 was purchased during the year, that discounts of $7,600 were earned by making early payments on these purchases, and that $6,800 worth of returns were made during the year. The records show that only 8,600 units of the beginning TC178 inventory remained at the end of the year. Burkett uses the perpetual LIFO system for calculating inventory. Their inventory transactions for item TC178 for the period are as follows: (NOTE that the vendor provides free shipping on all units of TC178) . At the beginning of the period, 9,600 units of TC178, purchased for $9.00 each, were on hand. . On Jan 15, an additional 29,000 units were purchased for $10.00 each. . On February 28, 26,000 units were sold. . On March 14, an additional 15,000 units were purchased for $12.00 each. . On March 20, a 3.0% cash discount was earned by paying for the March 14 purchase early. . On March 30, 17,000 units were sold. . On July 30, 5,800 units were sold. . On August 20, an additional 26,000 units were purchased for $15.00 each. • On September 2, 12,000 units were sold. . On December 1, 10,400 units were sold. Burkett's management would like to know the effect of the sale on the following ratios: • Inventory Turnover (COGS/ average total inventory) . Current Ratio . ROA Assignment: Calculations 1. Calculate each of the three (3) ratios before you make any adjustments. 2. Make the appropriate journal entries, if any, to correct the reported values of item TC178 (including any necessary changes to income tax expense). 3. Make any necessary changes to the financial statements. 4. Calculate the three (3) ratios after you make any adjustments. Critical Thinking 5. What do you think the investors' reaction will be to the adjustment of inventory? In other words, based on your changes to the financial statements and the change in the ratios, do you think investors will be happy with the restatement? Why or why not? Hints: 6. Who might be affected if the management team decided not to correct this error? Burkett's COO has repeatedly argued that no adjustment should be made to the current numbers. After all, she suggested, everything would be sold in the next period anyway. Why worry investors over something that is so unimportant? Defend your answer. 1. Start out by calculating Burkett's COGS on TC178 given the original information. The best way to do this is to set up a formal COGS calculation like the one we did in the Income Statement in Burkett #2. The formal calculation for one product would look just like the COGS section of the income statement, but it would only include the values for the one product. 2. Use the perpetual inventory method to find out what purchases, purchase discounts, and COGS should be for TC178 using a formal perpetual inventory table. Once you have those numbers, set up another formal COGS calculation like the one you made for the original information using the new information. 3. Compare the new COGS calculation to the old one. The differences between the two sets of calculations are the changes that you need to record in your journal entry. 4. When making your journal entry, keep in mind that Burkett has a perpetual inventory system. This means the company doesn't have a 'purchase returns' or a 'purchase discount' account. Instead, everything will be done using the inventory account. Your final entry, then, should change only three accounts: COGS, Inventory, and A/P. You can get the changes to COGS and Inventory from the differences in your COGS equations (old vs. new). You will use A/P as the plug figure. Why? Well, to explain that, we have to go back to what the original journal entries look like for a company that uses the perpetual inventory system. When we buy inventory in a perpetual system, we debit inventory and credit A/P. When we pay for inventory, we debit A/P and credit cash. If we get a discount or make a return, we debit A/P and credit Inventory. That means that any mistake in recording purchases, returns, or discounts would cause a mistake in both the Inventory account AND the A/P account. When we sell inventory, we would debit COGS and credit Inventory, so mistakes in recording sales would cause a mistake in both Inventory AND COGS. So, in order to correct for all of Burkett's mistakes, we need to adjust all three of those accounts: Inventory, COGS, and A/P. Sales Revenue Sales Revenue Less: Sales Discounts Sales Returns Terry Co. Multi-Step Income Statement For the Year Ended December 31, Year 2 Net Sales Revenue Cost of Goods Sold Gross Profit Cost of Goods Sold Operating Activities Selling Expenses Advertising Expense Miscellaneous Selling Expenses Sales Force Salaries Expense Selling Commissions Expense Shipping Expense Administrative Expenses Executive Salaries Expense Depreciation Expense Insurance Expense Miscellaneous Admin. Expenses Office Supplies Expense Consulting and Legal Fees Utilities Expense Total Administrative Expenses Income from Operations EPS $423,750 $110,175 $310,750 $1,130,000 $185,038 $988,750 $1,356,000 $194,925 $11,159 $87,575 $14,125 $169,500 Other Gains and Losses Rent Revenue Interest Expense Income from Continuing Operations before Taxes Income Tax Expense Net Income $271,200 ####林林林 $2,159,713 $2,822,034 $70,625 ($144,075) ######## $1,344,700 $21,255,300 $12,370,308 $8,884,992 $4,981,747 $3,903,245 ($73,450) $3,829,795 ($1,148,939) $2,680,856 $1.03 Current Assets Cash A/R Total Assets Allowance for Bad Debts Inventory Prepaid Insurance Prepaid Rent Total Current Assets Long-term Investments Loans to other businesses Expansion Fund Total Long-term Investments PPE Land Building Equipment Accumulated Depreciation Total PPE Intangible Assets Patents, net Current Liabilities Terry Co. Balance Sheet As of 12/31/Year 2 Accounts Payable Income Tax Payable Unearned Revenue Long-term Debt Assets Wages Payable Current Portion of Loan Payable Total Current Liabilities Loan Payable Notes Payable Liabilities and Stockholders' Equity $391,944 $395,500 $565,000 Total Long-term Debt Year 2 $1,026,000 $1,130,000 $2,034,000 $1,921,000 ($113,000) ($565,000) $2,712,000 $3,164,000 $349,500 $339,000 $282,500 $226,000 $6,291,000 $6,215,000 Retained Earnings Total Stockholders' Equity $904,000 $904,000 $678,000 $678,000 $1,582,000 $1,582,000 $2,486,000 $1,582,000 $1,808,000 $1,808,000 $6,328,000 $2,938,000 ($3,616,000) ($2,260,000) $7,006,000 $4,068,000 $339,000 $15,218,000 $271,200 $113,000 $1,736,644 $565,000 $3,164,000 Year 1 $3,729,000 $5,465,644 Total Liabilities Stockholders' Equity Common Stock ($1 par, 5,000,000 authorized, 2,600,000 outstanding) Additional Paid-In Capital $678,000 $6,474,356 $9,752,356 Total Liabilities and Stockholder $15,218,000 $339,000 $12,204,000 $1,356,000 $226,000 $339,000 $282,500 $113,000 $2,316,500 $678,000 $1,808,000 $2,486,000 $4,802,500 $2,600,000 $2,600,000 $678,000 $4,123,500 $7,401,500 $12,204,000 Terry Co. Statement of Cash Flows For Year Ended 12/31/Year 2 Cash Flow from Operations Net Income Adjustments: Change in A/R Change in Inventory Change in Prepaid Insurance Change in Prepaid Rent Depreciation & Amortization Change in A/P Change in Income Tax Payable Change in Unearned Revenue Change in Wages Payable Net Cash Flow from Operations Cash Flow from Investments Purchase of Land Purchase of Equipment Net Cash Flow from Investments Cash Flow from Financing Repayment of Loans Issuance of Notes Payable Payments of Dividends Net Cash Flow from Financing Net Increase (Decrease) in Cash Cash, January 1, Year 2 Cash, December 31, Year 2 ($565,000) $452,000 ($10,500) ($56,500) $1,356,000 ($964,056) $169,500 $226,000 ($11,300) ($904,000) ($3,390,000) ($113,000) $1,356,000 ($330,000) $2,680,856 $596,144 $3,277,000 ($4,294,000) $913,000 ($104,000) $1,130,000 $1,026,000 Financial Ratios Before Critical Thinking #1 Critical Thinking #2 After Final Journal Entries

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1Calculation of Ratios before adjustments Inventory Turnover Ratio COGS Average Total Inventory COGS Beginning Inventory Purchases Ending Inventory Beginning Inventory 9600 900 86400 Purchases 817000 ... View the full answer