Question

On December 30, Crane Co. accepted delivery of merchandise which it purchased on account. As of December 31, Crane had recorded the purchase, but did not include the merchandise in its physical count of ending inventory. The effect of this on its financial statements for December 31 would be

a. net income was correct and current assets were understated.
b. net income was understated and current liabilities were overstated.
c. net income was overstated and current assets were understated.
d. net income, current assets, and retained earnings were understated.

Answer 1

The failure to include merchandise in the physical inventory count leads to an understatement of current assets, net income, and retained earnings, with no impact on current liabilities.

Step-by-step explanation:

The scenario described involves Crane Co., a company that failed to include merchandise in its physical count of ending inventory while having recorded the purchase transaction. This accounting error will affect the financial statements as follows:

• Current assets on the balance sheet will be understated, since the inventory that was not counted is typically reported as a current asset.
• Since expenses (cost of goods sold) would be overstated by the cost of the uncounted inventory, net income on the income statement will be understated.
• Current liabilities will be correctly stated, assuming the purchase was properly recorded as an account payable.
• Retained earnings, which are impacted by the net income of the period, will also be understated due to the understatement of net income.

The correct choice, therefore, is option d. net income, current assets, and retained earnings were understated.