If Cost of Goods Sold was understated in Period 1, then Cost of Goods Sold and gross profit in Period 2 will be:

Question

Quizplus · Accepted Answer

If Cost of Goods Sold (COGS) was understated in Period 1, it means that the ending inventory for Period 1 was overstated (since COGS is the cost of inventory sold, and if less cost is recorded, more inventory value remains). This overstated ending inventory becomes the overstated beginning inventory for Period 2. Since COGS is calculated as Beginning Inventory + Purchases - Ending Inventory, an overstated beginning inventory will lead to an overstated COGS in Period 2. An overstated COGS will result in a lower gross profit, as gross profit is calculated as Sales - COGS. Therefore, COGS will be overstated and gross profit will be understated in Period 2.

If Cost of Goods Sold Was Understated in Period 1