Question

If year-end inventory is reduced from cost to a lower net realizable value, which of the following accurately depicts the results?

a) Cost of goods sold is reduced and beginning inventory of the next period is reduced by the same amount.
b) Year-end inventory is reduced and cost of goods sold is reduced by the same amount.
c) The capital account balance is increased and beginning inventory of the next period is reduced by the same amount.
d) Cost of goods sold is increased and beginning inventory of the next period is decreased by the same amount.

Answer 1

Reducing year-end inventory from cost to a lower net realizable value results in a reduction of inventory and an increase in cost of goods sold by the same amount, which subsequently decreases net income. Option b

Step-by-step explanation:

When year-end inventory is reduced to a lower net realizable value, this indicates that the inventory on the balance sheet is valued at its estimated selling price minus any costs to complete and sell it.

The correct answer to the student's question of what that reduction results in is: b) Year-end inventory is reduced and cost of goods sold is increased by the same amount. This adjustment reflects a loss in the current period. Therefore, the inventory asset on the balance sheet is reduced, and the loss is recorded on the income statement through an increased cost of goods sold, which in turn reduces the net income.

The beginning inventory for the next period would start at this new reduced amount, not at the cost. There is no direct impact on the capital account in the period when the inventory valuation adjustment occurs, aside from how the reduced income would subsequently affect retained earnings. Option b