If a company understates its ending balance of inventory in year 1 and it records inventory correctly in year 2, which one of the following is true?

Question

Quizplus · Accepted Answer

If the company understates its ending balance of inventory in year 1, the cost of goods sold will be overstated (COGS = beginning inventory + purchases - ending inventory). Therefore, in year 2, if the company records inventory correctly, the cost of goods sold will be understated. This means that choice B is correct. The understatement in COGS will result in an overstatement of net income in year 2. However, this does not affect the net income in year 1, so option A is incorrect. Retained earnings would also not be affected in year 2, so option D is incorrect.

If a Company Understates Its Ending Balance of Inventory in Year