At the end of 20X1, a $2,500 understatement was discovered in the amount of the 20X1 ending inventory as reﬂected in the perpetual inventory records. What were the 20X1 effects of the $2,500 inventory error (before correction)?
A) Assets (inventory) were understated by $2,500 and pretax proﬁt was understated by $2,500.
B) Assets (inventory) were understated by $2,500 and pretax proﬁt was overstated by $2,500.
C) Cost of goods sold was understated by $2,500 and pretax proﬁt was understated by $2,500.
D) Cost of goods sold was overstated by $2,500 and pretax proﬁt was overstated by $2,500.

Question

Quizplus · Accepted Answer

When ending inventory is understated, it means that the cost of goods sold (COGS) is overstated because COGS is calculated as beginning inventory plus purchases minus ending inventory. An overstated COGS leads to an understated pretax profit, as COGS is an expense that reduces profit. Therefore, both assets (inventory) and pretax profit were understated by $2,500.

At the End of 20X1, a $2,500 Understatement Was Discovered