What Is the Effect of an Unrecorded Purchase and Understated Ending Inventory on Financial Statements?
Introduction Errors in recording purchases and ending inventory can affect a company's financial statements, including its balance sheet, income statement, and financial ratios. However, the effect of an accounting error depends on how the error affects the related accounts. Suppose a company purchases goods on credit but accidentally fails to record the purchase and does not include those goods in its ending inventory. What happens to purchases, cost of goods sold, net income, accounts payable, retained earnings, working capital, and the current ratio? In this article, we will explain the effects of this accounting error under the periodic inventory system , using a practical example and simple calculations. What Happens When a Purchase Is Not Recorded? When an entity purchases goods on credit, it normally records the transaction as follows: Debit: Purchases Account Credit: Accounts Payable Account Under a periodic inventory system, purchases are recorded throughout the accoun...