Question

Waterway Company uses the LCNRV method, on an individual-item basis, in pricing its inventory items. The inventory at December 31, 2020, included product X. Relevant per-unit data for product X are as follows. Estimated selling price $48 Cost 37 Estimated selling costs 15 Normal profit 9 There were 1,000 units of product X on hand at December 31, 2020. Product X was incorrectly valued at $38 per unit for reporting purposes. All 1,000 units were sold in 2021. Compute the effect of this error on net income for 2020 and the effect on net income for 2021, and indicate the direction of the misstatement for each year. Net income for 2020 $ Net income for 2021 $

Answer 1

Answer:

2020 net income overstatement  $5,000

2021  net income understatement $5,000

Explanation:

The lower of cost and net realizable method of valuing inventory is used in valuing closing inventory where cost is invoice and NRV is the estimated selling price less cost to sell

Product       Cost  selling price cost to sell    NR   unit value

   X             $37          $48             $15            $33        $33

The inventory should have been  valued at $33 not at $38

This means that  inventory in 2020 was overstated by $5,000 ($38-$33)*1000)), costs of good sold in year 2020 was understated by $5,000 hence net income was overstated  by $5,000

The spillover effect in year 2021 is the reverse of 2020,hence understatement of net income by $5,000