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Subject Topic: accounting error - adjust R/E (Topic Closed Topic Closed) Post ReplyPost New Topic
  
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cwang1026
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Posted: 17 Sep 2010 at 00:55 | IP Logged  

Tack reported a retained earnings balance of $150,000 at 12/31/90. In June 1991, Tack discovered that merchandise costing $40,000 had not been included in inventory in its 1990 F/S. Tack has a 30% tax rate. What amount should Tack report as adj beginning R/E in its statement of R/E at 12/31/91?

Answer: $178,000

This is my understanding: The JE to correct merchandise in inventory would be:

Inventory............40,000
     A/P or Cash................40,000

When inventory is sold:
COGS.........40,000
     Inventory........40,000

In 1990, Net Income was OVERSTATED b/c COGS was not included. If we adjust the beginning R/E to correct this error, shouldn't we subtract the $40,000 (tax not calculated yet) instead?

Someone please tell me where my logic is off...b/c I really don't understand this problem.
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Mars
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Posted: 17 Sep 2010 at 07:15 | IP Logged  

I think it is based on the COGS formula,

that, at year end, you make a physcial count and calculate COGS

as follows: Beg+purchases-Ending = COGS

when inventory ending balance did not include an amount, that overstated COGS, which in turn understate income. by 40,000 which is 28,000 net of tax.

When you make adjustments, you have to take the tax into consideration, tax affects net income, the prior year net income was calculated after tax before it is included in R/E.

For me I prefer a shortcut, what I know from studying FIFO and LIFO that,

Inventory and Net income are directly proportional, increase and decrease together.

So, If inventory was understated, that makes N.I understated, but N.I will be net of tax when they mention the tax rate.

I hope this helps.

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cwang1026
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Posted: 17 Sep 2010 at 16:32 | IP Logged  

thanks mars! your explanations really helped!
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Mars
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Posted: 17 Sep 2010 at 17:19 | IP Logged  

You are welcome :)
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