Question

At the end of 2010, a $5,000 understatement was discovered in the amount of the 2010 ending inventory as reflected in the perpetual inventory records. What were the 2010 effects of the $5,000 inventory error (before correction)?

a. Assets were understated by $5,000 and pretax income was understated by $5,000.
b. Assets were understated by $5,000 and pretax income was overstated by $5,000.
c. Cost of goods sold was understated by $5,000 and pretax income was understated by $5,000.
d. Cost of goods sold was overstated by $5,000 and pretax income was overstated by $5,000.

Answer 1

Answer:

a. Assets were understated by $5,000 and pretax income was understated by $5,000.

Explanation:

Inventory are part of Current Assets in the Balance Sheet. This means that when they are understated, the Assets are also understated. Also understated inventory means that cost of sales are overstated in the Income Statement and consequently, Gross Profit and Pre-tax Income are understated.