The ending merchandise inventory for the current year is overstated by $20,000. What effect will this error have on the following year's Net Income?

Question

Quizplus · Accepted Answer

The ending merchandise inventory is a part of the Cost of Goods Sold (COGS) calculation. If the current year's ending inventory is overstated by $20,000, it means we have recorded $20,000 worth of inventory that was not sold in the current year. As a result, the COGS will be understated by $20,000, and Net Income for the current year will be overstated by $20,000. However, this year's overstated ending inventory will become the next year's beginning inventory. Thus, when computing the next year's COGS, the $20,000 overstatement from the previous year will reduce COGS, increasing the Net Income. So, next year's Net Income will be understated by $20,000, as the overstatement from last year will reduce COGS for the next year.

The Ending Merchandise Inventory for the Current Year Is Overstated