You have been hired as the new controller for the Ralston Company. Shortly after joining the company in 2016, you discover the following errors related to the 2014 and 2015 financial statements: a. Inventory at 12/31/2014 was understated by $6,000. b. Inventory at 12/31/2015 was overstated by $9,000. c. On 12/31/2015, inventory was purchased for $3,000. The company did not record the purchase until the inventory was paid for early in 2016. At that time, the purchase was recorded by a debit to purchases and a credit to cash. The company uses a periodic inventory system. Required: 1. Assuming that the errors were discovered after the 2015 financial statements were issued, analyze the effect of the errors on 2015 and 2014 cost of goods sold, net income, and retained earnings. (Ignore income taxes.) 2. Prepare a journal entry to correct the errors. 3. What other step(s) would be taken in connection with the error?

Answer and Explanation:

According to the scenario, computation of the given data are as follow:-

1). Effect of the errors on cost of goods sold:-

2014 - Cost of goods sold overstated by $6,000.

2015 - Cost of goods sold understated by $18,000.

Effect of the errors on net income:-

2014 - Retained earnings understated by $6,000.

2015 - Retained earnings overstated by $18,000.

Effect of the errors on net income:-

2014 - Retained earnings understated by $6,000.

2015 - Retained earnings overstated by ($9,000+$3,000)=$12,000.

2).Journal Entry to Rectify the Errors.

Cost of goods sold A/c Dr.  $6,000

    To Merchandise inventory A/c  $6,000

(Being the rectification of understated inventory of 2014 is recorded)

Merchandise inventory A/c  $6,000

    To Cost of goods sold A/c  $6,000

(Being the rectification of overstated inventory of 2015 is recorded)

3).If the financial statement is inaccurate resulting in one mistake in 2014 and the impact of three errors in 2015 and considering the correct inventory numbers, revenue, cost of goods sold and retained earnings will be retrospective until those figures are again recognized for comparative purposes in the annual report for 2016.

Retained earnings should be reported in an earlier period of adjustment, and a disclosure notice would also be made explaining the extent of the mistake and the effect of its correction on the net income, earnings per share and earnings before extraordinary items each year.

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