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A company had a beginning inventory that was understated by \$4,000 because the ending inventory in the previous period was understated by \$4,000. The amounts reflected in the current end of period balance sheet are:
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5. Inventory
Inventory Errors
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Which of the following statements regarding inventory errors is true?
A
Overstating beginning inventory will increase net income for the period.
B
An overstatement of ending inventory will overstate net income for the period.
C
Inventory errors only affect the current period and not future periods.
D
An understatement of ending inventory has no effect on the balance sheet.
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Understand the relationship between inventory and net income: Inventory errors can affect the calculation of Cost of Goods Sold (COGS), which in turn impacts net income. The formula for COGS is: .
Analyze the impact of overstating beginning inventory: If beginning inventory is overstated, COGS will be higher, which reduces net income. Therefore, the statement 'Overstating beginning inventory will increase net income for the period' is false.
Evaluate the impact of overstating ending inventory: If ending inventory is overstated, COGS will be lower, which increases net income. This makes the statement 'An overstatement of ending inventory will overstate net income for the period' true.
Consider the effect of inventory errors on future periods: Inventory errors in one period can carry over to the next period because the ending inventory of one period becomes the beginning inventory of the next. Therefore, the statement 'Inventory errors only affect the current period and not future periods' is false.
Assess the impact of understating ending inventory on the balance sheet: Understating ending inventory reduces assets (inventory is an asset) and also affects retained earnings (part of equity). Thus, the statement 'An understatement of ending inventory has no effect on the balance sheet' is false.
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