During an audit, it was discovered that ending inventory was overstated by $30,000 in Year 1. What is the effect of this error on Year 1 Cost of Goods Sold (COGS) and Year 1 Net Income?

Answer options:

COGS Overstated; Net Income Understated

COGS Understated; Net Income Overstated

COGS Overstated; Net Income Overstated

COGS Understated; Net Income Understated

How to approach this question

Use the COGS formula: Beg Inv + Purchases - End Inv = COGS. If End Inv is too high (overstated), the subtraction is too large, making COGS too low (understated). Low Expense = High Income.

Full Answer

B.COGS Understated; Net Income Overstated✓ Correct

COGS = Beg Inv + Purchases - End Inv.<br/>If End Inv is Overstated, COGS is Understated.<br/>Net Income = Sales - COGS.<br/>If COGS is Understated, Net Income is Overstated.

Common mistakes

Confusing the relationship between Inventory and COGS.

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