On December 27, Cloud Corp. accepted delivery of merchandise that it purchased on account. As at December 31, Cloud had recorded the transaction, but did not include the merchandise in its year-end inventory. The effect of this on its December 31 financial statements would be
A) net income, current assets, and retained earnings were understated.
B) net income was correct and current assets were understated.
C) net income was understated and current liabilities were overstated.
D) net income was overstated and current assets were understated.

Question

Quizplus · Accepted Answer

By not including the purchased merchandise in its year-end inventory, Cloud Corp. would have understated its current assets because the inventory is not reflected on the balance sheet. This also leads to an understatement of net income since the cost of goods sold would be overstated (assuming the inventory would have been sold), reducing net income. Consequently, retained earnings, which is affected by net income, would also be understated.