Question

Falk Company's ending inventory is understated $4,000. The effects of this error on the current year's cost of goods sold and net income, respectively, are:

(a) understated, overstated.
(b) overstated, understated.
(c) overstated, overstated.
(d) understated, understated.

Answer 1

If Falk Company understates its ending inventory, the cost of goods sold will be overstated, and therefore, net income will be understated for the current year.

Step-by-step explanation:

If Falk Company's ending inventory is understated by $4,000, the cost of goods sold (COGS) for the current year will be overstated because the ending inventory is subtracted from the goods available for sale to determine the COGS. Hence, if the ending inventory is too low, the COGS will appear too high. Consequently, overstating COGS leads to an understatement of net income, since COGS is an expense that is subtracted from revenues to determine net income. Thus, the effects of understating the ending inventory on the current year's COGS and net income, respectively, are overstated and understated.