Question

Understating the ending inventory balance has the following impact on the current year's income statement: U A Cost of goods sold is overstated and net income is understated. B) Cost of goods sold is understated and net income is understated. Cost of goods sold is overstated and net income is overstated. D Cost of goods sold is understated and net income is overstated. OE) Cost of goods sold is overstated and net income is correct.

Answer 1

Understating the ending inventory balance has the following impact on the current year's income statement:

Cost of goods sold is overstated and net income is understated.

Correct option is (A)

While calculating Cost of goods sold, ending inventory is subtracted. Thus, ending inventory and Cost of goods sold move in the opposite directions. Higher ending inventory means lower Cost of goods sold and lower ending inventory means higher Cost of goods sold.

Cost of goods sold = Beginning inventory + Purchases - Ending inventory

Cost of goods sold and Net income move in the opposite directions. Higher Cost of goods sold means lower net income and lower Cost of goods sold means higher net income.

Kindly give a positive rating if you are satisfied with the answer. Feel free to ask if you have any doubt. Thanks.