Inventories before, beginning

whaler

If the analyst discovered that beginning inventory was understated by $2,000, then earnings before taxes must have been overstated by $2,000.

If inventory is overstated then COGS must also be overstated or purchases were understated, since you are told that ending inventory is ok.

Anyone help with this?

dontknow1987

BI + P - EI = COGS
Say you plug in these numbers for above equation $3000 + 5000 - 2000 = $6000
Then if you understate BI by $2000, then the COGS becomes $4000 and hence EBT will increase by $2000 (that is overstated)

Also if BI is overstated by $2000, then it is either COGS must be overstated by $2000 or the P is understated by $2000 to arrive at the correct result, if the EI is ok.

Look at the original equation above again, if BI is overstated by $2000 you can either overstate COGS or understate Purchases. Here COGS becomes $8000 or P becomes $3000 if EI is still ok at $2000


Hope this helps!

JRossSter

Ok i *think* I get it.

COGS = Beginnign Inv + good produced during the period - Ending inv

Assuming goods produced during the period and ending inventory don't change a $2000 increase in beginning inventory will increase COGS. Basic math. Since COGS increased that will reduce net revenue (net revenue = sales - COGS) which will reduced earnings before taxes as the income statement is calculated.



Edited 1 time(s). Last edit at Friday, September 4, 2009 at 05:29PM by Steely Dan.