In early 20X4 at the Westfall Company, a team of internal auditors discovered that the ending inventory for 20X1 had been overstated by $10 million. Furthermore, the ending inventory for 20X3 had been understated by $5 million. The ending inventory for December 31, 20X2, was correct. The income tax rate is 40%.

1. Prepare a tabulation covering each of the 3 years that indicates which of the following items in the income statement are incorrect and by how much.

Beginning inventory

Cost of goods available

ending inventory

Cost of goods sold

Gross margin

Income before income taxes

Income tax expense

Net income

2. Is the amount of retained earnings correct at the end of 20X1, 20X2, and 20X3? If it is erroneous, indicate the amount and whether it is overstated (O) or understated (U).