Question

At December 31, 2016, Stacy McGill Corporation reported current assets of \(370,000 and current liabilities of \)200,000. The following items may have been recorded incorrectly.

1. Goods purchased costing \(22,000 were shipped f.o.b. shipping point by a supplier on December 28. McGill received andrecorded the invoice on December 29, 2016, but the goods were not included in McGill’s physical count of inventorybecause they were not received until January 4, 2017.

2. Goods purchased costing \)15,000 were shipped f.o.b. destination by a supplier on December 26. McGill received andrecorded the invoice on December 31, but the goods were not included in McGill’s 2016 physical count of inventorybecause they were not received until January 2, 2017.

3. Goods held on consignment from Claudia Kishi Company were included in McGill’s December 31, 2016, physical countof inventory at \(13,000.

4. Freight-in of \)3,000 was debited to advertising expense on December 28, 2016.

Instructions

(a) Compute the current ratio based on McGill’s balance sheet.

(b) Recompute the current ratio after corrections are made.

(c) By what amount will income (before taxes) be adjusted up or down as a result of the corrections?

Short answer

The current ratio with error and without error comes out to be 1.85 and 1.86, respectively.

Step-by-step solution

Current ratio without correcting the error

$$\begin{gathered} \mathbf{Current}\mathbf{}\mathbf{Ratio}\mathbf{}\mathbf{=}\frac{\mathbf{Current}\mathbf{}\mathbf{Assets}}{\mathbf{Current}\mathbf{}\mathbf{Liabilities}} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\frac{\mathbf{\$}\mathbf{370}\mathbf{,}\mathbf{0000}}{\mathbf{\$}\mathbf{200}\mathbf{,}\mathbf{000}} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\mathbf{1}\mathbf{.}\mathbf{85} \end{gathered}$$

Current ratio after error correction

1. $22,000 f.o.b. shipping point has been recorded. There is no correction required.

2. $15,000 f.o.b. destination has been recorded, which is an error as the title of the goods has not been received. So, the ending inventory would be adjusted by $15,000, and the accounts payable would also be lowered by $15,000.

3. Goods on consignment are not part of the inventory. So the current assets would be lowered by $13,000.

4. Freight in would be adjusted in inventory, and the value of current assets would increase.

Based on the above points, the correct value of the current ratio is as follows –

$$\begin{gathered} \mathbf{Current}\mathbf{}\mathbf{Ratio}\mathbf{}\mathbf{\left(}\mathbf{corrected}\mathbf{\right)}\mathbf{}\mathbf{=}\frac{\mathbf{Current}\mathbf{}\mathbf{Assets}\mathbf{}\mathbf{afetr}\mathbf{}\mathbf{adjustment}}{\mathbf{Current}\mathbf{}\mathbf{Liabilities}\mathbf{}\mathbf{afetr}\mathbf{}\mathbf{adjustment}} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\frac{\left(\$370,0000-\$15,000-\$13,000+\$3,000\right)}{\left(\$200,000-\$15,000\right)} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\frac{\mathbf{\$}\mathbf{345}\mathbf{,}\mathbf{000}}{\mathbf{\$}\mathbf{185}\mathbf{,}\mathbf{000}} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\mathbf{1}\mathbf{.}\mathbf{86} \end{gathered}$$

Adjustment in income

Only current assets and current liabilities are affected by the given transactions. The freight expense would be adjusted by the advertisement. So the total expense would remain the same. Thus there would be no effect on income before taxes.