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The draft 20X6 statement of financial position of Vale reported retained earnings of $1,644,900 and net assets of $6,957,300. It was then discovered that several items in opening inventory had been valued at selling price. This resulted in a $300,000 overstatement of opening inventory. The closing inventory had been correctly valued in the draft 20X6 financial statements.
What are the correct figures for retained profit and net assets in the statement of financial position for 20X6?
Retained earnings Net assets
A. $1,644,900 $6,657,300
B. $1,644,900 $6,957,300
C. $1,944,900 $6,657,300
D. $1,944,900 $6,957,300The correct answer is B.
As the error has been corrected (closing inventory is correct), both retained profit and net assets are correct as stated in the draft statement of financial position.
Tutorial note: Correction of the error would reduce the retained profit brought forward at the beginning of the current year (and therefore the prior year net assets) and increase the profit for the current year. These adjustments cancel each other out.
I don’t understand the answer at all. Since opening inventory was overstated, dont we remove that deduct that figure from retained earnings to get the correct figure and do the same with net assets as retained earnings is part of net assets?
The opening inventory was the same as the closing inventory of the previous year. So last years profit and this years profit will both have been wrong, but by the same amount. So the net figure for retained earnings at the end of this year is not affected.
For the net assets, they are the net assets at the end of this year. They include the inventory at the end of this year (they do not include the opening inventory) and the closing inventory has been valued correctly.
Unfortunately, I’m still confused. retained earnings b/f and the net assets b/f s are incorrect, so if we don’t make adjustment for the overstatement this year, our retained profits and net assets for this year will be incorrect. Won’t they?
Can you please elaborate why net assets don’t include the opening inventory?
Net assets is the sum total of all assets – all liabilities (including retained earnings from last year, the incorrect figure)or Net assets = share capital and reserves (which includes retained earnings, incorrect figure from last year).
The retained earnings figure for this year includes last year’s Retained earnings, won’t we make adjustment to get correct figure?
The net assets given are the net assets at the end of this year. They include the inventory at the end of this year which will have been counted at the end of this year and will be correct. Any error in the opening inventory has no effect on the closing inventory.
The retained earnings at the end of last year were wrong, and this does need correcting. However we then add on the profit for this year (to get the retained earning at the end of this year), and the profit this year also needs correcting. (The error in the opening inventory affects last years retained earnings and also this years profit). The net effect of correcting last years retained earnings and this years profit is zero – we increase one and decrease the other by the same amount.
I think I somewhat get it. The retained earnings b/f from last year are incorrect because they’re overstated by 300000. The profit for this year are also incorrect because they’re understated by 300000. So we reduce retained earnings b/f by 300000 and increase profit for this year by 300000 hence the net effect of adjustment to this year’s retained closing retained earnings is 0 (-300000+300000=0). Am I correct?
Do we get such mind bending questions in the main ACCA FA exam?
Yes – you are correct 🙂
(And I am afraid that you do get questions like this in the real Paper FA exam. However given that you are exempt, it will not be this sort of problem in the later exams 🙂 )
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