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A- understated net income this year B- understated retained earning this year C- understated net income next year D- understated retained earning next year
This will result in "understated net income next year"
This will increase the net profit for the period, show over valuation of inventory, Increase the Equity and leads to window dressing
Answer C is the right option .
Ans: C- understated net income next year
An overstated ending inventory will results the current period as an understated COS and overstated Net Income while effect of the ending Inventory of the current year which becomes the beginning inventory next year will gives an understated net income and a counterbalancing in terms of retained earnings since last year the value of retained earnings was overstated.
Answer option >>>>>>>>>>>>>>>> D- understated retained earning next year.
The company (X) is overstated its inventory which means they understated their sales which leads to understated their net income for that particular period.
Due to increase of company's closing inventory, company's cost of sale decreases. And therefore, company's Gross profit showing increase.
For example:
Sale 100 100
COGS:
Op. Stock 40 40
Purchases 50 50
Closing Stock (30) (60)
COGS (60) (30)
So, Gross Profit 40 70
In this year, Income will be high, but in the next year, when we make correction in the stock, then will be understated in the next Year.
If Closing inventory is overstated then Cost of Goods Sold increases which will decrease Gross income hence decreases net income. so right answer is
A- understated net income this year
Overstated of Inventory at the end of the period, this will result in understated net income next year.
C->>>>>>>>>>>>>> understated net income next year
A- understated net income this year
