It is discovered in 2016 that ending inventory in 2014 was understated. What is the effect of the understatement on the following: Questions For Review of Key Topics 2014: Cost of goods sold Net income Ending retained earnings 2015: Net purchases Cost of goods sold Net income Ending retained earnings
It is discovered in 2016 that ending inventory in 2014 was understated. What is the effect of the understatement on the following: Questions For Review of Key Topics 2014: Cost of goods sold Net income Ending
The effect of the understatement in 2014 on:
Cost of goods sold: The understated ending inventory will overstate the cost of goods sold. This is because, it is deducted from the sum of the beginning inventory and the net purchases. Thus, if a lower amount of ending inventory will be deducted, the cost of goods sold will increase.
Net income: The understated ending inventory will overstate the cost of goods sold. As a result, the overstated cost of goods sold will understate the net income. This is because, cost of goods sold is deducted from the sales revenue to determine the net income. Thus, if a higher amount of cost of goods sold will be deducted, the net income will decrease.
Ending retained earnings: The understated ending inventory will overstate the cost of goods sold. As a result, the overstated cost of goods sold will understate the net income and thus, understate the ending retained earnings. This is because, net income is added to the beginning retained earnings to determine the ending retained earnings. Thus, if a lower amount of net income will be added, the ending retained earnings will also be lower.
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