The following information is for Freds Furniture Factory (FFF), maker of unquestionably awesome sofas. FFF is a family owned business and operates as an LLC, with each of three brothers, Frank, Ferdinand and Fredo carrying on the sofa making tradition of their father, Fred.

FFF buys three bulk materials for their sofas- wood for the frames, fabric for the coverings and foam for the cushions. They buy in large quantities and hold the materials in stock to use as needed. When stocks reach a certain level, they are re-ordered. Also, during the year the FFF brothers hired a new accountant that had very little experience in accounting. The accountant was particularly concerned about the inventory accounting.

During the period under review, FFFs net income is lower than it has been the past two years. They have bought new equipment, but that has been properly accounted for. They have had steady operating costs at 17% of their gross margin. They have asked you, their outside accountant, to review their books and see if you can enlighten them on why their income is not correct. The data they have provided to you that was prepared manually by the new accountant appears below.

FFF, LLC Inventory Details for the past three years:
Year 1				Yr 1	Yr 2		Yr 3
Inventory on hand				$ 1,325	$ 2,475		$ 3,667
Purchases:
	Wood			786	826		732
	Fabric			477	632		486
	Foam			321	225		400
				1,584	1,683		1,618
Cost of Goods Sold				2,475	2,181		3,492
FFF, LLC	Income Statements			Year 1	Year 2		Year 3
	(In Millions)
Sales				$ 4,643	$4,288		4,548
COGS				(2,475)	(2,181)		(3,492)
Gross Margin				2,168	2,107		1,056
Operating expense				369	358		190
Net income before taxes				1,799	1,749		866

See the next page for requirements

After examining the financial information above, explain to the brothers why their net income was lower than expected in Year 3.

Prepare the journal entry required to correct the net income for Year 3.

Would the answer in question one impact the Balance Sheet at the end of year three?

The brothers want to make sure their yearend income look good even if correcting the income statement didnt take care of that. As the outside accountant, what do you say to this?