(LCNRV—Error Effect) LaGreca Company uses the LCNRV method, on an individual-item basis, in pricing its inventory items. The inventory at December 31, 2017, included product X. Relevant per-unit data for product X are as follows. Estimated selling price \(50 Cost 40 Estimated selling costs 14 Normal profi t 9 There were 1,000 units of product X on hand at December 31, 2017. Product X was incorrectly valued at \)38 per unit for reporting purposes. All 1,000 units were sold in 2018. Instructions Compute the effect of this error on net income for 2017 and the effect on net income for 2018, and indicate the direction of the misstatement for each year.

Net realizable value is calculated as follows:

$\begin{array}{rcl}\mathrm{Net}\mathrm{realizable}\mathrm{value}& =& \mathrm{Estmated}\mathrm{selling}\mathrm{price}-\mathrm{estimated}\mathrm{selling}\mathrm{cost}\\ & =& \$50-\$14\\ & =& \$36\end{array}$

The inventory cost per unit is $40, and the net realizable value per unit is $36. Per the LCNRV method, the cost of inventory per unit is $36, as it is the lowest of the two.

The inventory is incorrectly recorded at $38. However, the actual inventory price should be $36, which means ending inventory in the year 2017 is overstated by $2 per unit or a total of $2,000.

Also, in the year 2018, beginning inventory will be overstated by $2,000, as the ending inventory of 2017 is the beginning inventory of 2018.

Overstatement in inventory is calculated as follows:

$\begin{array}{rcl}\mathrm{Overstatement}\mathrm{in}\mathrm{inventory}& =& \mathrm{Total}\mathrm{units}\times (\mathrm{Incorrect}\mathrm{value}-\mathrm{InventoryValue}\mathrm{as}\mathrm{per}\mathrm{NRV})\\ & =& 1,000\times (\$38-\$36)\\ & =& 2,000\end{array}$

In the Year 2017, an overstatement in ending inventory of $2,000 will result in an overstatement of net income by $2,000. Ending inventory is subtracted to calculate the cost of goods sold. If ending inventory is increased cost of goods sold will decrease, and the decreased cost of goods sold will result in an increased (overstated) level of net income.

In the Year 2018, overstatement in the beginning inventory of $2,000 will result in an understatement of net income by $2,000. Beginning inventory is added to calculate the cost of goods sold. If beginning inventory is increased cost of goods sold will increase, and the increased cost of goods sold will result in decreased (Understated) level of net income.