Accounts officers at Xerox corporation discovered that significant errors have been made in the valuation of inventory and are worried that it might have significant impact on the Net Income and Earnings per share. What are the possible top 3 effects of the errors on net income? What could have been the top 2 reasons behind incorrect valuation of the inventory?


They have to consider the average cost, first in- first out, and last in- first out. Inflation plays a part in the three considerations. if there was no inflation then you would yeild the same result in all three considerations. If the company does not consider the value or cost of the inventory then this could throw off the balance sheet, income statement, and income cash flow. This equation shows how a company determines inventory; Beginning Inventory + Net Purchases - Cost of Goods Sold (COGS) = Ending

Inventory.Is this answer close?

morgaine300

This is not really what they are looking for. A company chooses an inventory method and they're supposed to stick to it unless there is a good reason to change it. (i.e. companies can't go around changing their accounting methods willy-nilly cause it makes the income statement look better or something.) So the method they are using has already been determined. Choosing a method is not the same thing as making an error.

What they are looking for you to understand is that all inventory only has two places to go: it either got sold, meaning the cost is now expensed in the Cost of Goods Sold, or they still have it and its cost is in the Inventory account (an asset). If the valuation of the inventory is off, that throws off both the inventory and the cost of goods sold. Notice the equation you wrote, the end of it being "... - COGS = Ending." So when one of those is off, the other is off as well. (An error in valuation of ending inventory will not affect beginging or purchases.)

Now, which one affects the net income? The COGS. So if that's off, so is net income. If it's off a little, no one cares. But it says they're "significant" errors.

Think through your income statement and where these numbers show up. It doesn't say if inventory was valued too high or too low. But it's irrelevant to the question. If you follow these errors through on the income statement, what is going to be affected? That's what they're asking.

I'm not sure what they're looking for as the "top 2" possible reasons for this error. Why are two specific reasons the "top" ones? No clue -- that's the kind of thing I think authors just make up and it's their opinion. Although one big reason is it got counted wrong. I can think of other reasons, but I don't know what other one they are looking for. Don't know if they're wanting you to make a reasonable guess, or if the book specifically mentioned something, in which case you'll have to go find it. (Or it could be the other reasons I'm thinking of, they are lumping into one big category or something. It's hard telling what authors might do.)