GoalTo practice correcting the financial statements for an inventory calculation error. (See Topic Guides A13, 14, 37, 38).

InformationTerry'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 12,900 units of item TC178, purchased for $12 each, were on hand at the beginning of the year, that $1,525,000 worth of TC178 was purchased during the year, that discounts of $11,300 were earned by making early payments on these purchases, and that $18,100 worth of returns were made during the year. The records show that only11,600 units of the beginning TC178 inventory remained at the end of the year.

Terry uses the perpetual LIFO system for calculating inventory. Their inventory transactions for itemTC178 for the period are as follows: (NOTE that the vendor provides free shipping on all units ofTC178)

-At the beginning of the period, 12,900 units of TC178, purchased for $12.00 each, were onhand

-On Jan 15, an additional 39,000 units were purchased for $13.00 each.

-On February 28, 35,000 units were sold.

-On March 14, an additional 21,000 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, 23,700 units were sold.

-On July 30, 7,800 units were sold.

-On August 20, an additional 35,000 units were purchased for $18.00 each.

-On September 2, 16,000 units were sold.

-On December 1, 14,000 units were sold.

Terrys 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

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?

6.Who might be affected if the management team decided not to correct this error? TerrysCOO 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.Start out by calculating Terrys 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 Terry #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 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 Terry has a perpetual inventory system. This means the company doesnt 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 toCOGS 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/Paccount. 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 Terrys mistakes, we need to adjust all three of those accounts: Inventory, COGS,and A/P.