Question

Am beauty inc. is a calendar-year corporation. its financial statements for the years 2026 and 2025 contained errors as follows: 2026 2025 ending inventory 12,000 overstated25,000 overstated what will be the impact on the 2025 financial statements? will these items be overstated or understated and by how much?

1) cost of goods sold
2) income before taxes
3) retained earnings

Answer 1

The overstatement of ending inventory by $25,000 in 2025 on Am Beauty Inc.'s financial statements would result in both income before taxes and retained earnings being overstated by the same amount.

Step-by-step explanation:

The impact of the inventory overstatement on Am Beauty Inc.'s 2025 financial statements would result in overstated income before taxes and retained earnings. When ending inventory is overstated, the cost of goods sold (COGS) is understated, leading to an overstatement of income before taxes. Assuming the error has not been corrected, in 2025 the income before taxes would be overstated by $25,000, which is the same amount as the overstatement of the ending inventory.

Similarly, the retained earnings at the end of 2025 would also be affected since the overstatement of income leads to more earnings being retained. Assuming no dividends were declared that year, the ending retained earnings for 2025 would be overstated by the same $25,000 as a direct result of the overstatement of income before taxes due to overstated inventory. In the next year, if this mistake is not corrected, it leads to a cumulated effect on financials.