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If inventory is understated at the end of the year, what is the effect on net income?

Accounting Financial Reporting Sales Finance
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Question added by Rehan Qureshi , Financial Consultant , Self Employeed
Date Posted: 2013/12/08
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Rehan Qureshi
by Rehan Qureshi , Financial Consultant , Self Employeed

If inventory is understated at the end of the year, the net income for the year is also understated. Here's a brief explanation. If a company has a cost of goods available of $100,000 and it assigns too little of that cost to inventory, then too much of that cost will appear on the income statement as the cost of goods sold. Too much cost on the income statement will mean too little net income.

Another way to view this is through the accounting equation, Assets = Liabilities + Owner's Equity. If you assign too little of the cost of goods available to Assets, then the amount of Owner's Equity will be too little—caused by net income being too little.

Muhammad Faheem
by Muhammad Faheem , Consultant- Accounts, Audit & Taxation , Basim Associates

Inventory (Ending) and net income moves in the similar direction. If inventory (ending)  understates, the net income will also understate.  While Inventory (ending) and cost of goods sold have inverse relation.

Ilham Mohammed
by Ilham Mohammed , Senior Accountant , gulf center for foodstuff

For Sure Net Profit Also understated. so end of the year profit will go up with the amount which is understated.

Kazi Aijaz Qureshi
by Kazi Aijaz Qureshi , Senior Accounts Officer , State Bank of Pakistan SBP BSC(BANK)

If inventory at the end of year i.e. closing stock, is understated it will increase cost of sales thereby, understating the profit or overstating loss.

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