Question

Question content area merchandise inventory at the end of the year was inadvertently overstated. which of the following statements correctly states the effect of the error on net income, assets, and owner's equity?

a. net income is understated, assets are understated, and owner's equity is overstated.
b. net income is overstated, assets are overstated, and owner's equity is understated.
c. net income is understated, assets are understated, and owner's equity is understated.
d. net income is overstated, assets are overstated, and owner's equity is overstated.

Answer 1

The correct answer is d. net income is overstated, assets are overstated, and owner's equity is overstated.

Here's why:

Net income: When the ending inventory is overstated, the cost of goods sold (COGS) is understated because there's a higher beginning inventory to deduct. A lower COGS leads to a higher gross profit and ultimately, a higher net income.

Assets: An overstated inventory means the carrying value of the current assets is inflated, leading to overstated total assets.

Owner's equity: Since net income is overstated, owner's equity (which is net income plus beginning owner's equity) will also be overstated.

Therefore, all three financial statement elements – net income, assets, and owner's equity – are overstated when the ending inventory is inadvertently overstated.

The correct answer is d