Inventory at the end of the year was inadvertently overstated. Which of the following statements correctly states the effect of the error on net income, assets, and stockholders' equity?

A net income is understated, assets are understated, and stockholders' equity is overstated

B net income is overstated, assets are overstated, and stockholders' equity is overstated

C net income is understated, assets are understated, and stockholders' equity is understated

D net income is overstated, assets are overstated, and stockholders' equity is understated

The movement in the balance of inventory at the start and end of a period is as a result of sales and purchases. While sales reduces the balance in inventory, purchases increases the balance. This may be expressed mathematically as

Opening balance + purchases - cost of goods sold = closing balance

Hence, where ending inventory balance is overstated, cost of goods sold is understated. When cost of goods sold is understated, gross and net incomes are overstated. Hence owner's equity is overstated and asset overstated.

jayilych4real jayilych4real · Answer 2 · 2021-11-18T19:09:07+01:00

The statement which correctly states the effect of the error on net income, assets, and stockholders' equity if the inventory is overstated is:

B. Net income is overstated, assets are overstated, and stockholders' equity is overstated

According to the given question, we are asked to show which of the statements are correct about the effect of overstating an ending inventory on net income and assets.

As a result of this, we recall that an inventory is the stock which is taken of products which are stored in a place and the movement in the balance of the inventory is dependent on the buying and selling of goods.

With this in mind, when an inventory at the end of the year is overstated, then the cost price of the goods are understated which means that the income and assets are overstated

Therefore, the correct answer is option B