What happens if you understate inventory

Exhibit 3 summarizes the effects of errors of inventory valuation:. Skip to main content. Chapter 6: Accounting For a Merchandising Enterprise.

Search for:. Impacts of Inventory Errors on Financial Statements Importance of proper inventory valuation A merchandising company can prepare accurate income statements, statements of retained earnings, and balance sheets only if its inventory is correctly valued. This relationship involves three items: First, a merchandising company must be sure that it has properly valued its ending inventory.

If the ending inventory is overstated, cost of goods sold is understated, resulting in an overstatement of gross margin and net income. Also, overstatement of ending inventory causes current assets, total assets, and retained earnings to be overstated. Thus, any change in the calculation of ending inventory is reflected, dollar for dollar ignoring any income tax effects , in net income, current assets, total assets, and retained earnings. Social studies. Ben Davis January 12, What happens if ending inventory is overstated?

What are some consequences if there are errors in the order and the inventory is too low or too high? How do you correct inventory errors? How do you know if you overstated or understated? What happens if assets are overstated? What does it mean when something is overstated? What is overstated income? What is overstated error? What is an example of overstatement? What is the effect of overstatement in poetry?

What is the difference between hyperbole and overstatement? What is understatement in figure of speech? An incorrect inventory balance causes an error in the calculation of cost of goods sold and, therefore, an error in the calculation of gross profit and net income. Left unchanged, the error has the opposite effect on cost of goods sold, gross profit, and net income in the following accounting period because the first accounting period's ending inventory is the second period's beginning inventory.

The total cost of goods sold, gross profit, and net income for the two periods will be correct, but the allocation of these amounts between periods will be incorrect. Since financial statement users depend upon accurate statements, care must be taken to ensure that the inventory balance at the end of each accounting period is correct. The chart below identifies the effect that an incorrect inventory balance has on the income statement. Balance sheet effects.

An incorrect inventory balance causes the reported value of assets and owner's equity on the balance sheet to be wrong. This error does not affect the balance sheet in the following accounting period, assuming the company accurately determines the inventory balance for that period.