Question 34

Net income is overstated by $15,000.

An overstatement of ending inventory by $15,000 results in lower cost of goods sold, which in turn inflates net income by the same amount. This misrepresentation directly impacts the financial statements, making net income appear higher than it truly is.

A) Cost of goods sold is overstated by $15,000.

This statement is incorrect. An overstatement of ending inventory leads to an understatement of cost of goods sold. Since ending inventory is included in the cost of goods sold calculation, a higher inventory value reduces the cost of goods sold, not increases it.

B) Net income is overstated by $15,000.

This statement is correct. When ending inventory is overstated, it reduces the cost of goods sold, which inflates net income by the same amount. This error makes the financial performance appear better than it actually is.

C) Current ratio is understated by $15,000.

This statement is incorrect. An overstatement of ending inventory increases current assets, which would actually lead to an overstated current ratio, not an understated one. Thus, this option does not accurately reflect the impact of the error.

D) Working capital is understated by $15,000.

This statement is incorrect. Overstating ending inventory increases total current assets, which positively affects working capital. Therefore, working capital would not be understated but rather overstated by the same amount.

Conclusion

In summary, the correct answer is that net income is overstated by $15,000 due to the overstatement of ending inventory. All other options fail to accurately represent the financial impact of the error, either mischaracterizing the effects on cost of goods sold, current ratio, or working capital. Understanding these relationships is crucial for accurate financial reporting and analysis.