If beginning inventory is understated by $1,300 and ending inventory is understated by $700,pretax profit for the period will be which of the following?
A)Understated by $600.
B)Understated by $2,000.
C)Overstated by $600.
D)Overstated by $2,000.

Question

Quizplus · Accepted Answer

Understating beginning inventory decreases cost of goods sold and increases gross profit. Understating ending inventory has the opposite effect, increasing cost of goods sold and decreasing gross profit. Therefore, understating both beginning and ending inventory results in an overstatement of gross profit which in turn leads to an overstatement of net income.

The correct calculation for the effect on pretax profit is:
Beginning inventory understated: +$1,300 
Ending inventory understated: +$700
Effect on gross profit: -$600 (gross profit is overstated by $600)
Assuming a tax rate of 0% (for simplicity): 
Effect on pretax profit: -$600 (pretax profit is overstated by $600)

Thus, the pretax profit is overstated by $600, so the answer is C.

If Beginning Inventory Is Understated by $1,300 and Ending Inventory