Question

Merchandise inventory at the end of the year was understated. Which of the following statements correctly states the effect of the error? a.Cost of merchandise sold is understated. b.Net income is overstated. c.Merchandise inventory reported on the balance sheet is overstated. d.Net income is understated.

Answer 1

Answer:

d.Net income is understated.

Explanation:

based on the inventory identity:

$Beginning Inventory + Purchase = Ending Inventory + COGS$

If merchandise at the end of the year is understated, to balance the identity the COGS must be higher than it should be.

Thus, the net income will have a greater COGS than it should. This will generate a net income which is lower than the correct income if merchandise inventory weren't understated.