Use the following information for the following questions:
Giselle Ltd. is a calendar-year corporation. Its financial statements for the years 2020 and 2019 contained errors as follows:
$$\begin{array} { l l l }
&2020&2019\
\text { Ending inventory } & \$ 2,000 \text { overstated } & \$ 3,000 \text { overtated } \
\text { Depreciation expense } & \$ 6,000 \text { understated } & \$ 12,000 \text { overstated }
\end{array}$$
-Assume that the proper correcting entries were made at December 31, 2019. By how much will 2020 pre-tax income be overstated or understated?
A) $2,000 understated
B) $2,000 overstated
C) $6,000 overstated
D) $8,000 overstated

Question

Use the following information for the following  questions:
Giselle Ltd. is a calendar-year corporation. Its financial statements for the years 2020 and 2019 contained errors as follows:
 $$\begin{array} { l l l } 
&2020&2019\
\text { Ending inventory } & \$ 2,000 \text { overstated } & \$ 3,000 \text { overtated } \
\text { Depreciation expense } & \$ 6,000 \text { understated } & \$ 12,000 \text { overstated }
\end{array}$$
-Assume that the proper correcting entries were made at December 31, 2019. By how much will 2020 pre-tax income be overstated or understated?
A) $2,000 understated
B) $2,000 overstated
C) $6,000 overstated
D) $8,000 overstated

Quizplus · Accepted Answer

The ending inventory error in 2019 will affect the cost of goods sold and gross profit in 2020. Since the ending inventory was overstated by $3,000 in 2019 and the proper correcting entry was made at that time, cost of goods sold in 2020 will be understated by $3,000 and gross profit will be overstated by $3,000.
The depreciation error in 2019 will affect the amount of accumulated depreciation and depreciation expense in 2020. Since the depreciation expense was overstated by $12,000 in 2019 and the proper correcting entry was made at that time, accumulated depreciation in 2020 will be overstated by $12,000 and depreciation expense will be understated by $12,000.
Therefore, pre-tax income in 2020 will be overstated by the net impact of both errors, which is $3,000 - $12,000 = $9,000. However, since depreciation expense is a non-cash expense, it will increase the amount of cash flow from operations in the statement of cash flows. Thus, the net increase in cash flow from operations will be $6,000 ($12,000 - $6,000), which is the amount by which pre-tax income will be overstated after considering the non-cash depreciation expense. 
Therefore, the correct answer is D, $8,000 overstated, after considering the impact of the non-cash depreciation expense.

Use the Following Information for the Following Questions: Giselle

Use the Following Information for the Following Questions:
Giselle