ExpertHard1 markMultiple Choice
CPA · Question 34 · Area 3: Select Transactions
In Year 2, Company X discovered it overstated Year 1 ending inventory by $10,000. The tax rate is 30%. What is the adjustment to the Year 2 beginning Retained Earnings?
In Year 2, Company X discovered it overstated Year 1 ending inventory by $10,000. The tax rate is 30%. What is the adjustment to the Year 2 beginning Retained Earnings?
Answer options:
A.
Decrease by $7,000
B.
Increase by $7,000
C.
Decrease by $10,000
D.
No adjustment needed as it self-corrects.
How to approach this question
Trace the error: Inv Up -> COGS Down -> NI Up -> RE Up. Correction: RE Down. Apply tax rate.
Full Answer
A.Decrease by $7,000✓ Correct
Overstating ending inventory understates COGS and overstates Net Income/Retained Earnings. The correction requires a debit (decrease) to Retained Earnings for the after-tax amount ($10,000 * 70% = $7,000).
Common mistakes
Ignoring tax effect; getting the direction wrong.
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