Questions:

A. By how much and in what direction (overstated of understated) will the firm's cost of goods sold be misstated?

B. If this error is not corrected, what effect will it have on the subsequent period's operating income?

C. If this error is not corrected, what effect will it have on the total operating income of the two periods (the period in which there is an error and the subsequent period) combined?

Answers:

A) Cost of Goods sold would be understated since COGS = OPening stock + Purchases - Ending Inventory.

B) Next year beginning inventory would be overstated which would mean higher COGS , Lower Gross profit and ulitimately lower income in next year.

C) Current year impact - Lower COGS , Higher Gross profit and ulitimately higher income. Higher assets and Higher Equity

Next year impact - Higher COGS , Lower Gross profit and ulitimately Lower income

Why does the error have the impact on both the initial period and the subsequent period. Can you see how one error impacts not only the period in which error is made, but potentially impacts subsequent periods as well?