Question

if a company understates its ending balance of inventory in year 1 and it reports inventory correctly in year 2, which one of the following is true? multiple choice net income is understated in year 2. cost of goods sold is understated in year 2. retained earnings is understated in year 2. net income is overstated in year 1.

Answer 1

If a company understates its ending balance of inventory in year 1 and reports inventory correctly in year 2, the cost of goods sold is understated in year 2.

Step-by-step explanation:

If a company understates its ending balance of inventory in year 1 and reports inventory correctly in year 2, the cost of goods sold is understated in year 2.

Cost of goods sold (COGS) is calculated as beginning inventory + purchases - ending inventory. Since the ending balance of inventory was understated in year 1, it would result in a lower COGS in year 2.

This in turn affects the net income in year 2. Net income is calculated as revenue - expenses, and COGS is considered an expense. If COGS is understated, it would result in a higher net income.