Question

During the taking of its physical inventory on December 31, Barry's Bike Shop incorrectly counted its inventory as $350,000 instead of the correct amount of $280,000. The effect on the balance sheet and income statement would be

a. assets overstated by $70,000; retained earnings understated by $70,000; and no effect on the income statement

b. assets, retained earnings, and net income all overstated by $70,000

c. assets and retained earnings overstated by $70,000 and net income understated by $70,000

d. assets overstated by $70,000; retained earnings understated by $70,000; and net income statement understated by $70,000

Answer 1

Solution:
	Answer is b. assets, retained earnings, and net income all overstated by $70,000
Working Notes:
	Correct inventory value is $280,000
	But inventory was booked at $350,000
	Hence, Inventory is overstated by ($350,000 - $280,000 = $70,000)
	And Inventory is Assets so Assets is overstated by $70,000
	Net income is directly related with Ending inventory value and which is overstated by $70,000 . So Net income is also overstated by this incorrect overstating of Ending Inventory.
	In Retained earnings, balance of net income at end of period is added .And as we know net income is already overstated due to incorrect inventory . As resultant of this Retained earnings is also overstated by $70,000
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