Question

Regan Corporation's December 31, 2015, ending inventory was understated by $42,000. What effect will this understatement have on total assets and net income for 2015?

Assets Net income
A understate No effect
B No effect No effect
C understate understate
D No effect overstate

Answer 1

Understating the ending inventory will result in both total assets and net income being understated for the fiscal year. This affects the balance sheet and the income statement respectively, leading to inaccuracies in the financial reporting of the corporation.

Step-by-step explanation:

When inventory is understated, it causes a ripple effect in financial reporting. At year-end, an understated inventory will reduce the cost of goods sold because ending inventory is an integral part of the cost of goods sold calculation. This, in turn, falsely increases the net income since the cost of goods sold is understated.

Additionally, because inventory is an asset, underreporting it will similarly understate total assets on the balance sheet.

The correct answer to the question would be: Ending inventory understatement will understate total assets and understate net income for 2015, corresponding to option C on your list.

This is because the ending inventory figure is directly added to total assets, and proper accounting would adjust net income downwards due to the increased cost of goods sold if the inventory were correctly stated.