ExpertMedium1 markMultiple Choice
ACCA · Question 54 · Recording Transactions: Inventory
Section B - Case 2
Scenario: EcoBuild Ltd is preparing financial statements for the year ended 30 September 20X6. Draft profit before tax is $450,000. Adjustments required:
- A machine costing $120,000 bought on 1 April 20X6 was incorrectly expensed in full. Depreciation is 20% straight-line (pro-rata).
- Closing inventory was undervalued by $15,000.
- An allowance for receivables of $8,000 needs to be created.
- Rent of $12,000 paid for the quarter ending 30 November 20X6 was fully expensed.
How does the undervaluation of closing inventory (adjustment 2) affect the draft profit?
Section B - Case 2
Scenario: EcoBuild Ltd is preparing financial statements for the year ended 30 September 20X6. Draft profit before tax is $450,000. Adjustments required:
- A machine costing $120,000 bought on 1 April 20X6 was incorrectly expensed in full. Depreciation is 20% straight-line (pro-rata).
- Closing inventory was undervalued by $15,000.
- An allowance for receivables of $8,000 needs to be created.
- Rent of $12,000 paid for the quarter ending 30 November 20X6 was fully expensed.
How does the undervaluation of closing inventory (adjustment 2) affect the draft profit?
Answer options:
A.
It decreases profit by $15,000.
B.
It increases profit by $15,000.
C.
It has no effect on profit.
D.
It increases profit by $30,000.
How to approach this question
Remember the formula: Cost of Sales = Opening Inventory + Purchases - Closing Inventory. If Closing Inventory goes up by $15,000, Cost of Sales goes down by $15,000. Lower expenses mean higher profit.
Full Answer
B.It increases profit by $15,000.✓ Correct
Closing inventory is deducted when calculating Cost of Sales. If closing inventory was undervalued, correcting it means increasing the closing inventory figure by $15,000. This decreases Cost of Sales by $15,000, which in turn increases Gross Profit and Net Profit by $15,000.
Common mistakes
Thinking that an increase in an asset (inventory) is an expense that reduces profit.
Practice the full ACCA FA — Financial Accounting Practice Exam 6
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