Janet Chao, accountant of Seaward Electronics Ltd., learned that Seaward Electronics’s $24 million cost of inventory at the end of last year was overstated by $3.0 million. She notified the company president, Eric Moffat, of the accounting error and the need to alert the company’s lenders that last year’s reported net income was incorrect. Moffat explained to Chao that there is no need to report the error to lenders because the error will counterbalance this year: This year’s error will affect this year’s net income in the opposite direction of last year’s error. Even with no correction, Moffat reasons, net income for both years combined will be the same whether or not Seaward Electronics corrects its errors.
Required
1. Was last year’s reported net income of $37.0 million overstated, understated, or correct?
What was the correct amount of net income last year?
2. Is this year’s net income of $41 million overstated, understated, or correct? What is the correct amount of net income for the current year?
3. Whose perspective is better, Chao’s or Moffat’s? Give your reason. Consider the trend of reported net income both without the correction and with the correction.
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