Final answer:
Underapplied overhead means not all indirect production costs are allocated, which results in an understatement of COGS and WIP, and an overstatement of finished goods. The correct answer is D.
Step-by-step explanation:
The effect of underapplied overhead is that it doesn't fully allocate the indirect costs of production to products. Here's what happens to the cost of goods sold (COGS), work in process (WIP), and finished goods with underapplied overhead:
- COGS is understated because the total cost of products sold is not fully accounted for.
- WIP is understated because the current work has not absorbed all the indirect costs it should have.
- Finished goods are overstated because they carry fewer costs than they should.
The correct answer to this question, therefore, is option D: Understate COGS, overstate WIP, and overstate finished goods.