Question

Several years ago, the financial statements of Gibson Greeting Cards, now part of American Greetings, contained the following note: On July 1, the Company announced that it had determined that the inventory … had been overstated.… The overstatement of inventory … was $8,806,000. Gibson reported an incorrect net income amount of $25,852,000 for the year in which the error occurred and the income tax rate was 39.3 percent. Required: 1. Compute the amount of net income that Gibson reported after correcting the inventory error.

Answer 1

Answer:

$20,506,758 .00

Explanation:

The movement in inventory over a given period may be given as

Opening balance + purchases - cost of goods sold = closing balance

As such, an overstatement of the closing balance would result in an understatement of the cost of goods sold. An understatement of the cost of goods sold would in turn result in gross and net income and vice versa.

If the overstatement of inventory was $8,806,000, this means that cost of sales was understated by the same amount. Given that the reported incorrect net income amount of $25,852,000 and tax rate was 39.3%,

Income before tax = $25,852,000/(1 - 0.393)

= $42,589,785.83

Corrected income before tax = $42,589,785.83  - $8,806,000.00

= $33,783,785.83

Net income after tax =  $33,783,785.83 - (39.3% × $33,783,785.83)

= $20,506,758 .00