Problem: Effects of inventory errors. Following are condensed income statements for Uncle Bill’s Home Improvement Center, for the years ended December 31, 2003, and 2002.
Uncle Bill was concerned about the operating results for 2003 and asked his recently hired accountant, “If sales increased in 2003, why was net income less than half of what it was in 2002?” In February of 2004, Uncle Bill got his answer: “The ending inventory reported in 2002 was overstated by $23,500 for merchandise that we were holding on consignment on behalf of Kirk’s Servistar. We still keep some of their appliances in stock, but the value of these items was not included in the 2003 inventory count because we don’t own them.”
1) Recast the 2002 and 2003 income statements to take into account the correction of the 2002 ending inventory error.
2) Calculate the combined net income for 2002 and 2003 before the correction of the error and after the correction of the error. Explain to Uncle Bill why the error was corrected in 2003 before it was actually discovered in 2004.
3) What effect, if any, will the error have on net income and owners’ equity in 2004?