Question

If the amount of ending inventory is overstated, the amount of which financial metric will be affected?

a) Revenue
b) Cost of Goods Sold
c) Gross Profit
d) Net Income

Answer 1

An overstated ending inventory decreases COGS, which in turn increases gross profit and net income, thereby affecting the net income metric.

Step-by-step explanation:

If the amount of ending inventory is overstated, this error will affect the reported amount of Cost of Goods Sold (COGS). An overstatement of ending inventory leads to an understatement of COGS, because the inventory that was not actually sold is incorrectly stated as being still on hand. As COGS is reduced, both gross profit and net income are consequently overstated, since these metrics are calculated after COGS is deducted from Revenue:

• Gross Profit = Revenue - COGS
• Net Income = Gross Profit - Operating Expenses (and other expenses/taxes)

Therefore, the amount of net income will be directly affected by an overstated ending inventory. It is important to ensure accurate inventory accounting to provide reliable financial information.