Charles Scrab Inc. has beginning inventory of $15,000, purchases of $25,000, and ending inventory of $10,000, sales of $75,000, operating expenses of $30,000, and a tax rate of 40% for 2008. An accounting clerk input the ending inventory as $12,000. What is the effect on 2008 net income?

Question

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The ending inventory was overstated by $2,000 ($12,000 instead of $10,000), which means the cost of goods sold was understated by $2,000. This results in a higher reported net income by $2,000. After tax adjustment (40%), the net income is $1,200 higher.