If ending inventory on December 31,2014,is overstated by $40,000,what is the effect on net income for 2015?
A) Net income is overstated by $40,000.
B) Net income is understated by $40,000.
C) Net income is overstated by $80,000.
D) The answer cannot be determined from the information given.

Question

Quizplus · Accepted Answer

If ending inventory in 2014 is overstated by $40,000, it means that the cost of goods sold (COGS) for 2014 is understated by the same amount, because COGS = Beginning Inventory + Purchases - Ending Inventory. As a result, net income for 2014 is overstated by $40,000. Then, in 2015, the overstatement in inventory carries over to the beginning inventory. Consequently, COGS is overstated by $40,000 for 2015, which leads to an understatement of net income for the same amount. Therefore, the answer is B, net income is understated by $40,000.

If Ending Inventory on December 31,2014,is Overstated by $40,000,what Is