Question

At the balance sheet date, Clarkson Company held title to goods in transit amounting to $214,000. This amount was omitted from the purchases figure for the year and also from the ending inventory. What is the effect of this omission on the net income for the year as calculated when the books are closed? What is the effect on the company’s financial position as shown in its balance sheet? Is materiality a factor in determining whether an adjustment for this item should be made?

Short answer

Due to the omission of inventory, net income will be overstated and the current assets will be understated. Yes, materiality is a factor while making adjustments.

Step-by-step solution

Effect on net income

The title for the goods in transit belongs to the company. Thus this value should have been included in the ending inventory and purchases.

As a result, the purchase will be understated and consequently, the COGS will also be understated.

So, the net income will be overstated.

Effect on the balance sheet

If the purchases have been understated, the ending inventory will also be understated. So, as a result, the current assets of the company will be understated.

Materiality factor

The materialistic factor is the basis of accounting. As per the accounting principle, only materialistic events should be recorded. Thus the omission of recording inventory needs adjustment in the books of accounts.