Question

1). In the notes for our financial statements, our company says that we use the FIFO inventory cost flow assumptions; however, our accountant accidentally used the LIFO inventory cost flow assumption when creating out financial statements. If we were experiencing a period of increasing inventory costs, how would this impact our financial statement?

2). The value of inventory purchased on account was understated.

For both questions, write if those understated or overstated or NE.

:Assets Liabilities SE

:Rev Exp NI

I understand that Assets are understated for both problems, but not sure if I need to understate Equity or Liabilities.

How do you know to understate the equity or liability when assets are understated?

Please include your explanations in detail. Thanks!

Answer 1

Equity and liabilities are also understated because of profit. Since because of using LIFO method our inventory is understated , so accordingly profit is also understated and hence when this profit is transferred to equity then that became understated.

Example - open stock $1000

Closing stock $1500

Purchase = $10000

Sales = $12000

In this example cost of goods sold

= Opening + Purchase - closing stock

= $1000 + $10000 - $1500

= $9500

Profit = sales - cost of goods sold

= $12000 - $9500

= $2500

Now suppose if closing stock is understated by $500.

So cost of goods sold would be

= $1000 + $10000 - $1000

= $10000

Hence new profit = $12000 - $10000 = $2000

So now profit has reduced

I hope you understood...

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