How would an error in valuation of inventory affect the accounts?

Question 1

What happens when an error is made in the valuation of ending inventory?

Answer 1

It would affect the profits reported reported for the current and the next financial period.

Question 2

Error in the valuation of inventory and its effects in the current financial period:
What are the effects on gross profit, expenses, profit, owner’s equity, current assets and total assets when ending inventory is overvalued / when impairment loss on inventory is not recognised?

Answer 2

When ending inventory is overvalued / overstated, the effects in the current financial period are:
Gross profit: No impact as the goods are not sold
Total Expenses: Understated
Profit: Overstated
Owner’s equity: Overstated
Current assets: Overstated
Total assets: Overstated

Question 3

Error in the valuation of inventory and its effects in the next financial period:

Where are the effects on gross profit, expenses, profit and owner’s equity when ending inventory in the current financial period is overvalued / overstated or when impairment loss on inventory is not recognised in the current period?

Answer 3

When ending inventory in the current financial period is overvalued / overstated or when impairment loss on inventory is not recognised in the current period:

Cost of sales: Overstated
Gross profit: Understated
Profit: Understated
Owner’s equity: Understated

Question 4

What are the steps to follow when there is an error in the valuation of inventory?

Answer 4

1. Identify the reason why inventory is overstated or understated. Identify the accounts affected.
2. Analyse how the error in inventory affects these accounts.

Question 5

What is the general rule when there is an error in the valuation of inventory?

Answer 5

As a general rule,

• gross profit will be affected if inventory is sold
• current assets will be affected if inventory is not sold.