Storm Windows Company understated their ending inventory during their first year of operations by $2,000. What is the effect of this error at the end of the year? Select all answers which apply.Multiple select question.$2,000 overstatement of net income.$2,000 overstatement of cost of goods sold.$2,000 understatement of net income.$2,000 understatement of cost of goods sold.
Question
Storm Windows Company understated their ending inventory during their first year of operations by 2,000 overstatement of net income.2,000 understatement of net income.$2,000 understatement of cost of goods sold.
Solution
The effect of understating ending inventory by $2,000 at the end of the year would be:
- $2,000 overstatement of cost of goods sold.
- $2,000 understatement of net income.
Here's why:
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Overstatement of Cost of Goods Sold (COGS): When ending inventory is understated, it means that more inventory is assumed to have been sold than actually was. This increases the Cost of Goods Sold (COGS), which is the cost to the business of the inventory that has been sold to customers.
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Understatement of Net Income: An increase in COGS reduces gross profit and, consequently, net income. Therefore, if COGS is overstated (as it is in this case), net income will be understated.
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