A $25,000 overstatement of the 2013 ending inventory was discovered after the financial statements for 2013 were prepared. Which of the following describes the effect of the inventory error on the 2014 financial statements?
A) Net income and stockholders' equity are both understated.
B) Net income is understated and stockholders' equity is correct.
C)Net income and stockholders' equity are both overstated.
D)Net income and stockholders' equity are both unaffecteD.The overstatement of the 2013 ending inventory causes the 2013 net income to be overstated and the 2014 net income to be understated. Stockholders' equity at the end of 2014 is correct because inventory errors are counter-balancing.

Question

Quizplus · Accepted Answer

The overstatement of the 2013 ending inventory causes the 2013 net income to be overstated. However, since the error is discovered after the financial statements are prepared, it cannot be corrected in the 2013 financial statements. Therefore, the error will affect the beginning inventory for 2014, causing cost of goods sold to be overstated and net income to be understated in 2014. Since the error does not affect stockholders' equity, the correct answer is B, net income is understated and stockholders' equity is correct.

A $25,000 Overstatement of the 2013 Ending Inventory Was Discovered