If ending inventory at the end of the year is understated, what is the effect on cost of goods sold and net income?Multiple choice question.Cost of goods sold will be overstated and net income will be overstated.Cost of goods sold will be understated and net income will be understated.Cost of goods sold will be overstated and net income will be understated.
Question
If ending inventory at the end of the year is understated, what is the effect on cost of goods sold and net income?Multiple choice question.Cost of goods sold will be overstated and net income will be overstated.Cost of goods sold will be understated and net income will be understated.Cost of goods sold will be overstated and net income will be understated.
Solution
The correct answer is: Cost of goods sold will be overstated and net income will be understated.
Here's why:
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If ending inventory is understated, it means that less inventory is reported than there actually is.
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This would mean that more inventory is assumed to have been sold during the year.
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The cost of goods sold (COGS) is calculated based on the amount of inventory sold. If more inventory is assumed to have been sold, the COGS will be higher, or overstated.
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Net income is calculated as revenues minus expenses. COGS is one of the main expenses for a company. If COGS is overstated, it means that expenses are overstated.
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If expenses are overstated, net income (revenues - expenses) will be lower, or understated.
So, if ending inventory is understated, COGS will be overstated and net income will be understated.
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