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 a company understates its count of ending inventory in year 1, which of the following statements is correct?

Net income in year 1 will be understated, and net income in year 2 will be overstated.

Net income in both year 1 and year 2 will be understated.

Net income in both year 1 and year 2 will be unaffected.

Net income in year 1 will be overstated, and net income in year 2 will be understated.

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Verified step by step guidance

Step 1: Understand the relationship between ending inventory and net income. Ending inventory is a component of the Cost of Goods Sold (COGS) calculation, which directly impacts net income. The formula for COGS is: \( \text{COGS} = \text{Beginning Inventory} + \text{Purchases} - \text{Ending Inventory} \). If ending inventory is understated, COGS will be overstated, leading to a lower net income.

Step 2: Analyze the impact on year 1. Since the ending inventory for year 1 is understated, COGS for year 1 will be overstated, resulting in an understated net income for year 1.

Step 3: Consider the impact on year 2. The ending inventory of year 1 becomes the beginning inventory of year 2. If the ending inventory of year 1 is understated, the beginning inventory of year 2 will also be understated. This will cause COGS for year 2 to be understated, leading to an overstated net income for year 2.

Step 4: Evaluate the options provided in the problem. Based on the analysis, the correct statement is: 'Net income in year 1 will be understated, and net income in year 2 will be overstated.'

Step 5: Reflect on the importance of accurate inventory counts. Errors in inventory reporting can have a cascading effect on financial statements, impacting decision-making and financial analysis across multiple periods.