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Financial & Managerial Accounting
Found in: Page 222
Financial & Managerial Accounting

Financial & Managerial Accounting

Book edition 7th
Author(s) John J Wild, Ken W. Shaw, Barbara Chiappetta
Pages 1096 pages
ISBN 9781259726705

Short Answer

BTN 4-4 You are the financial officer for Music Plus, a retailer that sells goods for home entertainment needs. The business owner, Vic Velakturi, recently reviewed the annual financial statements you prepared and sent you an e-mail stating that he thinks you overstated net income. He explains that although he has invested a great deal in security, he is sure shoplifting and other forms of inventory shrinkage have occurred, but he does not see any deduction for shrinkage on the income statement. The store uses a perpetual inventory system.


Prepare a brief memorandum that responds to the owner’s concerns.

Inventory shrinkage is not deducted from the income statement because a perpetual inventory system is applied in the business, and external auditors are also satisfied with the inventory control.

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Step by Step Solution

Step-by-Step SolutionStep 1: Definition of Financial Statements

Statements that summarize all the financial transactions in a fiscal year are known as financial statements. It reports revenue, expenses, resources, and liabilities.

Step 2: Memorandum

Date: xx-xx-xxxx

To: Business Owner

From: Financial Officer

Subject: Reason for not including shrinkage in the income statement.

This memorandum concerns the overstatement of net income and inventory shrinkage. The company has implemented a perpetual inventory system for recording the inventory, and under this system, the inventory balance is updated after each sale and purchase. Also, the company is reconciling the balance through a physical inspection of the inventory. Any identified difference is corrected immediately, and therefore, there is no chance of error.

Also, the auditors of the business entity are satisfied with the control over the inventory system. There is no space for inventory shrinkage, and therefore, it has not been included in the income statement as deduction.

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