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Hello,
I have come across a question on my BPP P&R CD which I am having difficulty answering, please can you help to explain this for me?
Question:
“The Accountant at Investotech discovered the following errors after calculating the comapny’s profit for 20X3:
1. A Non Current Asset costing $50,000 has been included in the Purchases Account
2. Stationery costing $10,000 has been included as closing inventory of raw materials, instead of stationery expenses.
What is the effect of these errors on gross profit & net profit?
1. The non-current asset should not have been included in purchases (it should be on the Statement of financial position). Taking it out of purchases will increase the gross profit and increase the net profit – both by $50,000
2. The fact that they have closing inventory of stationery, means that the net expense for stationery should be reduced. But they have reduced the cost of sales (because they treated it as materials). So…..the gross profit will be reduced by $10,000 (because having to increase the cost of sales), but the net profit will not be affected (the gross profit is lower, but the stationery expense will be lower by the same amount).
(Just one point about (1). Because it had been treated as purchases, there will not have been any depreciation charged on it, which there should have been. So…..the profit would also have to be adjusted for the depreciation. However since there are no details given in the question, you could not be expected to do anything about that 🙂 )
Hope that helps!
Hello!
Thanks for your response very helpful explanation, although I think the answers are based on not correcting the errors, so therefore this would be the correct answer?
1. Understatement of gross profit by $40,000 and understatement of Net Profit $50,000
These questions hurt my brain!!
Thanks 🙂
Vicki
Can I just ask why the Net Profit is not affected? I understand the first part, but cannot understand why the 10,000 does not affect the Net Profit… am I missing something?
The point is that there is $10,000 in inventory – it is just that it is inventory of stationery (and therefore should reduce the stationery expense, which appears below ‘gross profit’).
What they have done instead is reduce cost of sale (by treating as inventory of goods), which appears above ‘gross profit’.
So the final net profit is not affected, but because it is in the wrong place, it means that the gross profit at present is too high, and the expenses at the moment are too high.
When we correct it, the gross profit will reduce, but because the expenses will also reduce, then net profit will not be affected.Is it clear now? Please do let me know if not 🙂
Hi Jonh,
I’m also having problem with this question too@vixengard said:
Hello,I have come across a question on my BPP P&R CD which I am having difficulty answering, please can you help to explain this for me?
Question:
“The Accountant at Investotech discovered the following errors after calculating the comapny’s profit for 20X3:
1. A Non Current Asset costing $50,000 has been included in the Purchases Account
2. Stationery costing $10,000 has been included as closing inventory of raw materials, instead of stationery expenses.
What is the effect of these errors on gross profit & net profit?
In the book the answer is
A. Understatement of gross profit by $40,000 and understatement of net profit by $30,000I already read your explanation to Vicki for this question however I still don’t understand; moreover, I’m abit confused because you said Vicki’s answer is right but it’s different from the book.
Please explain for more detail. Thanks
@vixengard said:
Hello!Thanks for your response very helpful explanation, although I think the answers are based on not correcting the errors, so therefore this would be the correct answer?
1. Understatement of gross profit by $40,000 and understatement of Net Profit $50,000
These questions hurt my brain!!
Thanks 🙂
Vicki
@johnmoffat said:
That is correct 🙂
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