Ending inventory for the year ended December 31, 2010, is understated. How will this error affect net income for 2010 and 2011?

Question

Quizplus · Accepted Answer

If ending inventory is understated, the cost of goods sold will be overstated, which will lead to a lower net income in 2010 (as cost of goods sold is subtracted from revenues to calculate net income). However, the following year (2011), the effect will be reversed, as the understated ending inventory will be overstated in the beginning inventory of 2011, leading to a lower cost of goods sold and a higher net income for that year.

Ending Inventory for the Year Ended December 31, 2010, Is