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

Which of the following best describes the effect of overstating ending inventory on the current year's financial statements?

Net income will be understated and assets will be understated.

Net income will be overstated and assets will be overstated.

Net income will be overstated, but assets will be understated.

Net income will be unaffected, but assets will be understated.

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Verified step by step guidance

Understand the relationship between ending inventory and financial statements: Ending inventory is a component of the Cost of Goods Sold (COGS) calculation, which directly impacts net income. Additionally, ending inventory is reported as an asset on the balance sheet.

Analyze the impact on COGS: If ending inventory is overstated, the COGS will be understated because the formula for COGS is: \( \text{COGS} = \text{Beginning Inventory} + \text{Purchases} - \text{Ending Inventory} \). Lower COGS leads to higher net income.

Evaluate the effect on net income: Since COGS is understated, net income will be overstated because \( \text{Net Income} = \text{Revenue} - \text{Expenses} \), and COGS is an expense.

Assess the impact on assets: Ending inventory is reported as an asset on the balance sheet. Overstating ending inventory will result in overstated assets.

Conclude the overall effect: Overstating ending inventory causes both net income and assets to be overstated in the current year's financial statements.