Effects Of Incorrect Stock Valuation On Profit For The Current And Subsequent Periods (Part 9)

In the earlier article, any overstatement of the closing stock valuation will lead to an overstatement of the gross profit and consequently the net profit for the CURRENT period.

The next thing we need to understand is that the closing stock of one period is the opening stock for the subsequent period. So, what will the impact on the Income Statement.

As the overstated closing stock is CARRIED FORWARD to the subsequent period as the OPENING STOCK, this will result in the understatement of gross profit and net earning/profit (opposite impact for the first year where profits are overstated)

Illustration:

Year 1: Closing Stock was wrongly valued as $3,000 should only be $1,000, therefore overstated closing stock by $2,000

	Year 1	REMARKS
Revenues	10,000
Cost of Goods Sold:
Purchases	5,000
Less :Closing Stock	3,000	Assuming the correct stock valuation should be $1,000, hence closing stock overvalued by $2,000
Cost of Goods Sold:	2,000
Gross Profit Margin	8,000	Overstated by $2,000

Year 2: Closing Stock C/F as Opening Stock as $3,000 which is overvalued in Year 1 by $2,000

     Â	Impact to Year 2	OPENING STOCK FOR YEAR 2 OVERSTATED BY $2,000
Â	Â	Â
Revenues	10,000
Cost of Goods Sold:		Â
OPENING STOCK	3,000	Opening stock =Last Year’s Closing stock (overvalued by $2,000)
Purchases	5,000	Â
Less :Closing Stock	1,000	Assuming there is nothing wrong with this closing stock for Year 2.
Cost of Goods Sold:	7,000	Cost of Goods Sold is OVERSTATED due to Overstated opening stock c/f from last year’s closing stock
Gross Profit Margin	3,000	Gross Profit margin now is UNDERSTATED BY $2,000 DUE TO OVERVALUATION OF OPENING STOCK