Question

Which of the following is true if a company overstates ending inventory in Year 1 but reports ending inventory correctly in Year 2?

a) Net Income is overstated in Year 2.
b) Cost of goods sold is overstated in Year 1 Net income is understated in Year 1.
c) Retained earnings is overstated in Year 1

Answer 1

If a company overstates ending inventory in Year 1 but reports ending inventory correctly in Year 2, it will result in an overstatement of net income in Year 1.

Step-by-step explanation:

If a company overstates ending inventory in Year 1 but reports ending inventory correctly in Year 2, it will result in an overstatement of net income in Year 1. Net income is calculated by subtracting the cost of goods sold (COGS) from the total revenue, and an overstatement of ending inventory will lead to a lower COGS, thereby increasing net income.

Therefore, the correct option is a) Net Income is overstated in Year 2.

It is important for companies to accurately report their financial statements to ensure the integrity of the financial information and provide reliable information to stakeholders.