Inventory Analysis

Inventory Turnover Ratios
1. Inventory turnover ratio = Cost of goods sold / Average inventory
2. Days in inventory = 365 days / Inventory turnover ratio

Exercise
Cost of goods sold = $60,000
Beginning inventory = $12,000
Ending inventory = $18,000

Calculate the following:
(1) Inventory turnover ratio
(2) Days in inventory

Average inventory = (Beginning inventory + Ending inventory) / 2
= ($12,000 + $18,000) / 2 = $15,000
(1) Inventory turnover ratio = $60,000 / $15,000 = 4.0
(2) Days in inventory = 365 / 4.0 = 91.25

Inventory Errors
1. Cost of goods sold = Beginning inventory + Purchases – Ending inventory
2. If ending inventory is overstated, cost of goods sold is understated.
3. If cost of goods sold is understated, net income is overstated.
4. If ending inventory is understated, cost of goods sold is overstated.
5. If cost of goods sold is overstated, net income is understated.

Exercise
During the physical inventory taking, Entity T counted 100 units of merchandise twice. Because of double counting, ending inventory of Entity T was overstated by $17,000. Which of the following is correct?
a. Total assets was understated by $17,000.
b. Cost of goods sold was overstated by $17,000
c. Net income was overstated by $17,000
d. Total liabilities was overstated by $17,000

 [Answer]
(C) is correct.
If ending inventory is overstated, cost of goods sold is understated.
If cost of goods sold is understated, net income is overstated.
If ending inventory is overstated, total assets is overstated.
Total liabilities is not affected by the overstatement of inventory due to double counting.

 

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