Accounting Help

Question

A) Considering the year-ending adjusting journal entries for the periodic inventory system. If I miscount my ending inventory, what is the effect on the balance sheet? What is the effect on the income statement? For example, at the year-end inventory count, there is a mistake and I count 30,000 units of inventory when 29,000 actually exist. I make the year-end journal entries with 30,000 as my number of units in inventory. What is the effect on the balance sheet and income statement for that year?

B) What is true about the balance sheet in year 2 if my ending inventory count is correct in year 2 (after being miscounted in year 1)? What about the income statement in year 2?

Answer 1

Hello Kiera,

If you were to miscount your ending inventory, there would obviously be a misstatement on the balance sheet of ending inventory. If you did a year end count and counted 100 when there was really only 90, then your ending inventory would be overstated. If this happened, then your cost of goods sold would be understated, because you think that you have more on hand at the end of the year, meaning that you did not think that you used as much as you actually did. If your COGS is understated, then your net income will be overstated, which will in turn make your retained earnings overstated by that same amount.

In the second year, when you count the inventory correctly, your errors will reverse on your income statement and your balance sheet will now be correct. If you counted 150 in the second year, and there were actually 150, then your balance sheet will be correct. Your income statement, though, will be still effected from the first year. If in the previous year you overstated the ending inventory, that means that your beginning inventory for year 2 is overstated. If your beginning inventory is overstated, that means that your COGS would now be overstated as well, because to get to the proper ending inventory you would need to record a higher COGS. In turn, if COGS is overstated, then your net income will be understated, and in turn your retained earnings will be understated.

I hope this helped! Let me know if you have additional questions!