During 2009, P Company discovered that the ending inventories reported on its financial statements were incorrect by the following amounts: P uses the periodic inventory system to ascertain year-end quantities that are converted to dollar amounts using the FIFO cost method. Prior to any adjustments for these errors and ignoring income taxes, P's retained earnings at January 1, 2009 would be

Question

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The ending inventory is overstated by $60,000 on December 31, 2008, and by an additional $90,000 on December 31, 2009. This means that the cost of goods sold (COGS) is understated by $150,000 for the year 2009. Since net income is calculated as revenues minus expenses (including COGS), an understatement of COGS causes an overstatement of net income. Retained earnings is calculated by adding net income to the beginning balance of retained earnings and subtracting any dividends declared. Therefore, an overstatement of net income causes an overstatement of retained earnings. Since the amount of the overstatement of net income is $150,000, the answer is C) $150,000 overstated.

During 2009, P Company Discovered That the Ending Inventories Reported