A $25,000 overstatement of the 2015 ending inventory was discovered after the financial statements for 2015 were prepared. Which of the following describes the effect of the inventory error on the 2016 financial statements?
A)Net income and stockholders' equity are both understated.
B)Net income is understated and stockholders' equity is correct.
C)Net income and stockholders' equity are both overstated.
D)Net income and stockholders' equity are both unaffecteD.The overstatement of the 2015 ending inventory causes the 2015 net income to be overstated and the 2016 net income to be understated.Stockholders' equity at the end of 2016 is correct because inventory errors are counter-balancing.

Question

Quizplus · Accepted Answer

The overstatement of inventory in 2015 resulted in an overstatement of net income for that year. However, this error will be corrected in 2016 when the inventory is sold and the cost of goods sold is recorded correctly, causing the net income for 2016 to be understated. Therefore, the effect of the error on the 2016 financial statements is that the net income is understated, but the stockholders' equity is not affected because inventory errors are counterbalancing.

A $25,000 Overstatement of the 2015 Ending Inventory Was Discovered