I don't even understand this with the explanation. Can somebody explain how not being able to determine the beginning balance of inventory overstates net income???
Before year 2, Droit Co. used the cash basis of accounting. As of December 31, year 2, Droit changed to the accrual basis. Droit cannot determine the beginning balance of supplies inventory. What is the effect of Droit’s inability to determine beginning supplies inventory on its year 2 accrual basis net income and December 31, year 2 accrual-basis owners’ equity?
Year 2 Net income——–12/31/Y2 Owners' equity
Understated—————No effect
Understated————–Understated
Overstated—————No effect
Overstated—————Overstated
This answer is incorrect. Inability to determine beginning supplies inventory would cause supplies expense to be understated and year 2 net income to be overstated. Cumulative supplies expense would be properly stated so there would be no effect on December 31, year 2 retained earnings.
FAR- 81
REG- 81
BEC- Aug 22, 2016
AUD- TBD
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