Table of contents

1. Introduction to Accounting1h 21m
2. Transaction Analysis1h 13m
3. Accrual Accounting Concepts2h 38m
4. Merchandising Operations2h 30m
5. Inventory1h 55m
6. Internal Controls and Reporting Cash1h 16m
7. Receivables and Investments3h 8m
8. Long Lived Assets5h 1m
9. Current Liabilities2h 19m
10. Time Value of Money1h 23m
- Time Value of Money Equations
  35m
- Using Time Value of Money Tables
  47m
11. Long Term Liabilities2h 45m
12. Stockholders' Equity2h 15m
13. Statement of Cash Flows2h 24m
14. Financial Statement Analysis5h 25m
15. GAAP vs IFRS56m

5. Inventory

Inventory Errors

Financial Accounting

5. Inventory

Inventory Errors

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Multiple Choice

If you are managing inventory of raw materials and you overstate the ending inventory, what is the immediate effect on net income for the period?

Net income will be zero

Net income will be overstated

Net income will be understated

Net income will not be affected

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Verified step by step guidance

Understand the relationship between inventory and net income: In financial accounting, the ending inventory is a component of the Cost of Goods Sold (COGS) calculation. COGS is subtracted from revenue to determine gross profit, which directly impacts net income.

Recall the formula for COGS: \( \text{COGS} = \text{Beginning Inventory} + \text{Purchases} - \text{Ending Inventory} \). If ending inventory is overstated, COGS will be understated because a higher ending inventory reduces the amount subtracted in the formula.

Analyze the impact on gross profit: Since COGS is understated, gross profit will be overstated. Gross profit is calculated as \( \text{Revenue} - \text{COGS} \), so a lower COGS leads to a higher gross profit.

Connect gross profit to net income: Net income is derived from gross profit after accounting for operating expenses, taxes, and other items. If gross profit is overstated, net income will also be overstated for the period.

Conclude the immediate effect: Overstating the ending inventory results in an overstated net income for the period because of the direct relationship between inventory, COGS, gross profit, and net income.