Income Tax SLP2
Income Tax SLP2
The initial income statement of Nybrostrand Company does not reflect year-end adjustments to be made. On making these adjustments, final version of the income statement is prepared for the period ending 31 December 2014 in accordance with US GAAP.
Adjusting entry: inventory
As the purchase of products worth of 42,500$ has not been effected by the client, and the sales account has already been adjusted for the amount of the revenues for these goods, cost of goods sold (COS) should be adjusted as well in accordance with matching concept (FASB,1985). The adjusting entry will increase year-end inventory by 42,500$ (goods coming back to the warehouse as the dispatch has not occurred) and decrease COS by 42,500$. This will have a positive effect on the income statement giving an additional income of $ 42,500 compared to the original version: net income of $ 161 150 (Table 2) vs. $ 118 650 (Table 1). The amount of $ 161 150 will go to the current year retained earnings.
The adjusting entry of $ 42,500 which has been made (Table 2, Note) is an example of matching concept application. Matching concept is one of the backbones of FASB Conceptual Framework (FASB, 1985; FASB, 2010) which uses accrual basis of accounting. This means that financial results of all events and transactions should be reflected in the financial statements in the period when they occur (FASB, 1985, para 139). This gives rise to a matching concept which requires that revenues and expenses arising directly and jointly from the same events should be reflected in the same accounting period (FASB, 2010, para 146). That implies that expense related to sales (COS) arises at the same time when the sale occurs. Correspondingly, both revenues and COS account should be charged with the appropriate amounts in the same accounting period.If the accountant has already made a reversal of sale transaction within the year 2014, the corresponding COS transaction should also be reversed. That is reflected by $ 42 500 adjusting entry. If the matching concept is not followed, the information presented in the income statement does not reflect the real company profitability (in Nybrostrand example, net income could have been decreased by $ 42 500) and may mislead the users of financial statements in taking their economic decisions.
The adjustment of COS by 42 500$ worth closing inventory for the sale which has not taken place is made in accordance with matching concept of accounting. Non-compliance with matching concept can distort the information they contain. The adjusted income statement, with 42 500$ increase of income, illustrates the company real profitability and presents true and fair view of the entity performance.
Financial Accounting Standards Board (FASB) (1985). Financial Accounting Standards Board Concept Statement No 6. Elements of Financial Statements Retrieved from: http://www.fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1218220132831&acceptedDisclaimer=true
Financial Accounting Standards Board (FASB) (2010). Financial Accounting Standards Board Concept Statement No 8. Conceptual Framework for Financial Reporting Retrieved from: http://www.fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1176157498129&acceptedDisclaimer=true