Final answer:
An understated ending inventory by $18,000 would cause both the balance sheet and income statement to reflect inaccuracies: total assets and net income would be understated by $18,000 each. The balance sheet would show lower current assets and the income statement would show higher COGS and lower profits for the year the error occurred.
Step-by-step explanation:
If Wakowski Company’s ending inventory was actually $86,000 but was adjusted at year-end to a balance of $68,000 in error, the impact on the financial statements would be significant. Inventory is a current asset on the balance sheet, so if it is understated by $18,000, total assets would also be understated by the same amount. Moreover, on the income statement, Cost of Goods Sold (COGS) would be overstated. The inventory error would result in the profits being understated because when the ending inventory is reduced, the COGS increases, which in turn reduces the net income.
Here is how the error would look mathematically:
• Overstated COGS: $18,000 (because ending inventory is understated)
• Understated Net Income: $18,000 (due to the overstatement of COGS)
• Understated Total Assets: $18,000 (because inventory is part of current assets on the balance sheet)
For the year in which the error occurred, the company’s financial health may appear worse than it actually is. This would mislead stakeholders by presenting a weaker financial position and profitability. It is crucial for companies to ensure accuracy in their inventory valuation as it has a direct impact not only on the financial statements but also on ratios like the current ratio and profit margins, which are key indicators of company performance. Correcting the error in the subsequent period would involve adjustments to the opening inventory and retained earnings.