CMA Study Group

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  • 1.  inventory

    Posted 25 days ago
    Merchandise that was purchased on account was accepted by the Orion Company. As of December 31, Orion had recorded the transaction using the periodic method, but did not include the merchandise in its inventory. What would be the effect of this on the financial statements for December 31?

    could someone please explain how cogs are over stated.

    A: current asset, retained earning, NI understated.
    as per my understanding since inventory is understated cogs will be understated and NI  overstated. 

  • 2.  RE: inventory

    Posted 25 days ago
    Hi Kirti,

    To calculate COGS under the periodic method, the following formula is use:

    Beginning Inventory + Purchases - Ending Inventory = Cost of Goods Sold

    Let me give you an example below:

    Scenario-01 (if merchandise of $10,000 is included in the inventory ) 
    Cost of Goods Sold
    Inventory-beg.   100,000.00
    Add: Purchases     50,000.00
    Goods available for sale   150,000.00
    Less: Inventory-end     90,000.00     60,000.00

    Scenario-02 (if merchandise of $10,000 is omitted in the inventory ) 
    Cost of  Goods Sold
    Inventory-beg.   100,000.00
    Add: Purchases     50,000.00
    Goods available for sale   150,000.00
    Less: Inventory-end     80,000.00     70,000.00

    As you can see, in Scenario-2, where the goods are omitted resulted in an overstated COGS amounting to $10,000. Under the periodic method, the inventory balance is not updated on a continuous basis, but the COGS and the value of ending inventory is determined by conducting a physical count of the inventory on hand at the end of the period.

    Remember COGS and ending inventory have an inverse relationship, meaning if the latter is understated, the former will be overstated. 

  • 3.  RE: inventory

    Posted 25 days ago

    Since given  that the merchandise is not included in inventory.
    Thus, Ending inventory is understated and therefore the  corresponding  COGS will be overstated. See the below example for more clarity with note no.1

    Particulars: Case-I if included in inventory Case-II  Did not included in inventory
      in $ in $
    Beginning Inventory                                            10,000.00                                                           10,000.00
    Plus :Purchases                                            14,000.00                                                           14,000.00
    Less: Ending Inventory( as per Periodic Inventory system)                                             -6,000.00                                                            -4,000.00
    Cost of Good Sold                                            18,000.00                                                           20,000.00
    In this example Case-II,  the amount of $2,000 inventory has not been considered in ending inventory.
    Note for Case-II
    1. If Beginning inventory and Purchases are recorded  correctly,
    however, inventory items are excluded from ending inventory: Then COGS will be overstated and Net income
    retained earnings, working capital will be understated
    2. If purchase on account is not recorded  and also not included in the  ending
    inventory  then  no impact or effect on COGS and NI. However, CA & CL is understated  

    Kishore Kumar N