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

A company started the year with $10,000 of inventory. If the ending inventory is overstated by $2,000, what is the effect on net income for the year?

Net income will be overstated by $10,000.

Net income will not be affected.

Net income will be overstated by $2,000.

Net income will be understated by $2,000.

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Verified step by step guidance

Step 1: Understand the relationship between inventory and net income. In financial accounting, ending inventory affects the cost of goods sold (COGS), which in turn impacts net income. If ending inventory is overstated, COGS will be understated, leading to an overstatement of net income.

Step 2: Recall the formula for COGS: $ \text{COGS} = \text{Beginning Inventory} + \text{Purchases} - \text{Ending Inventory} $. If ending inventory is overstated, the subtraction in the formula will result in a lower COGS.

Step 3: Analyze the impact of understated COGS. Since $ \text{Net Income} = \text{Revenue} - \text{COGS} - \text{Expenses} $, a lower COGS increases net income, causing it to be overstated.

Step 4: Determine the amount of overstatement. The problem states that ending inventory is overstated by $2,000. This directly reduces COGS by $2,000, leading to an overstatement of net income by the same amount.

Step 5: Conclude that the correct answer is: Net income will be overstated by $2,000, as the overstatement in ending inventory directly inflates net income by the same amount.