Confused By Error Correction
I'm prepping form my Financial accounting exam and I have come across a particular question and no matter how I work it out, I do not get to what it says the correct answer is in the book..Here goes!
After calculating your company's profit for 2003, you discover that
a) A non-current asset costing £50,000 has been included in the purchases account
b) Stationery costing £10,000 has been inclued as closing inventory of raw materials, instead of inventtory of stationery. The two errors have the effect of
A) Understating gross profit by £40,000 and understating net profit by £50,000
B) Understating both gross profit and net profit by £40,000
C) Understating gross profit by £60,000 and net profit by £50,000
D) Overstating both gross profit and net profit by £60,000.
The correct answer in the book is A, which at a glance might seem obvious, but here is my problem. Both items are included in cost of sales, so you take the £50k out of purchases and the £10k out of closing inventory, this will reduce your costs by £40k and therefore increase your Gross profit by £40k. Fine.
But when you apply the £10k charge to the income statement for stationery and then lift it to inventory the net proifit difference comes out at £40k not £50k, below I give two quick P&L examples
Inc Errors Corrections
Sales 750,000 750,000
Opening Inventory 40,000 40,000
Purchases 450,000 400,000 (non-current asset taken out)
Closing inventory (30,000) (20,000) (stationery taken out)
Cost of Sales 460,000 420,000
Gross Profit 260,000 300,000
Wages 100,000 100,000
Admin Exps 25,000 25,000
Depreciation 15,000 15,000
Credit Sationery A/C to invntory (10,000)
Net Profit 120,000 160,000 - £40,000 DIFFERENCE NOT £50
Is it me or am I missing the point!!!! Help!!!!!