Goal: Intermediate 1 FSR Project Part #5: Inventory Basics To practice correcting the financial statements for an inventory calculation error. (See Topic Guides A 13, 14, 42, 43). Information: Dover'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 the following values for item TC178: Beginning Inventory $122,400 10,200units @ $12.00 per unit Purchases $1,204,000 Pur Discount ($8,600) Pur Returns ($13,800) $1,181,600 COGAS $1,304,000 Ending Inventory COGS $110,400 9,200 units of beginning inventory @ $12.00 per unit $1,193,600 Dover uses the perpetual LIFO system for calculating inventory. Their actual 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, 10,200 units of TC178, purchased for $12.00 each, were on hand. . On Jan 15, an additional 31,000 units were purchased for $13.00 each. . On February 28, 28,000 units were sold. On March 14, an additional 16,000 units were purchased for $15.00 each. . On March 20, a 3.0% cash discount was earned by paying for the March 14 purchase early. . On March 30, 18,200 units were sold. On July 30, 5,900 units were sold. . On August 20, an additional 28,000 units were purchased for $18.00 each. . On September 2, 13,000 units were sold. . On December 1, 11,200 units were sold. Dover's management would like to know the effect of your adjustment on the following ratios: Inventory Turnover (COGS/ average total inventory) . Current Ratio ROA Assignment: Calculations 1. Make the appropriate journal entries, if any, to correct the reported values of item TC178 (including any necessary changes to income tax expense). 2. Make any necessary changes to the financial statements. Critical Thinking 3. Calculate each of the required ratios using the original values (before any changes) and the updated values (after your changes). 4. How do you think market analysts will react to the corection to inventory? Do you think they will downgrade their recommendation from buy to hold or sell? Why or why not? 5. Who might be affected if the management team decided not to correct this error? Dover'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. Hints: 1. Use a perpetual LIFO table to find out what purchases, purchase discounts, and COGS should be for TC178. If it helps, we create a perpetual LIFO table in video 5 of our Recording Inventory videos, starting about 8 minutes in. 2. Once you have the correct numbers, set up t-accounts for COGS and Inventory. In your accounts, use the current values of TC178 provided in the Information section as the beginning account balances. Now set the correct balances from your perpetual LIFO table as the desired ending balances in each account. What would you need do to change the current, incorrect balances into the desired, correct balances? 3. You probably noticed right away that the changes to ending inventory and COGS will not lead to a balanced journal entry. That means you need one more account. Since Dover uses a perpetual inventory system, they only have three (3) accounts that deal with inventory: COGS, Inventory, and A/P. Since you know from your t-accounts what the changes will be to COGS and inventory, you can use A/P as the plug figure to make your entry balance. 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. Overall, in order to correct for all of Dover's mistakes with TC178, we need to adjust all three accounts: Inventory, COGS, and A/P