Wildhorse Company uses the LCNRV method, on an individual-item basis, in pricing its inventory items. The inventory at December 31, 2020, included product X. Relevant per-unit data for product X are as follows. Estimated selling price $49 Cost 39 Estimated selling costs 15 Normal profit 9 There were 990 units of product X on hand at December 31, 2020. Product X was incorrectly valued at $38 per unit for reporting purposes. All 990 units were sold in 2021. Compute the effect of this error on net income for 2020 and the effect on net income for 2021, and indicate the direction of the misstatement for each year.

Net income for 2020  = $6,360  Overstated

Net income for 2021 = $6,360   Understated

Explanation:

The computation of net income for 2020 and the effect on net income for 2021 is shown below:-

Net realizable value per unit = Estimated selling price - Estimated selling expenses

= $49 - $15

= $34

Total value of ending inventory = 990 × $34

= $33,660

Incorrect value = 990 × $38

= $37,620

So, ending inventory of 2020 is overstated by

= $37,620 - $33,660

= $3,960

Overstatement of ending the inventory reduces the expense of the products sold and thereby raises the 2020 net profit by $3,960

The ending 2020 inventory is the beginning inventory for 2018. Overstatement of ending 2020 inventory leads to over establishment of beginning 2021 inventory. Increased beginning inventory results in higher cost of produced products and lower net profits.

Net income of 2021 is understated by $3,960

Net income for 2020     $6,360  Overstated

Net income for 2021     $6,360   Understated

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