Since net income increases the equity account Retained Earnings, if net income is understated, then equity will also be understated.

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Quizplus · Accepted Answer

This is true because Retained Earnings is a component of equity, and it reflects the cumulative profits that a company has retained for reinvestment or distribution to shareholders. If net income is understated (i.e. reported lower than it actually is), then the amount added to Retained Earnings will be lower, which in turn lowers overall equity. This can skew financial ratios and make a company appear less profitable or stable than it really is.

Since Net Income Increases the Equity Account Retained Earnings, If