Question

If the ending inventory of a firm is overstated by $58,000, by how much and in what direction (overstated or understated) will the firm's operating income be misstated? (Hint: Use the cost of goods sold model, enter hypothetically "correct" data, and then reflect the effects of the ending inventory error and determine the effect on cost of goods sold.) Operating income__________ by _________

Answer 1

Answer:

The firm's operating income will be overstated by $58,000.

Explanation:

Cost of Goods Sold Model is as below

Opening Inventory                           xxx

Add: Cost of goods manufactured xxx

Cost of goods available for sale    xxx

Less: Ending inventory                     xxx

Cost of goods sold                           xxx

It is the cost of goods sold so obtained, that is taken to the income statement. Hence, overstatement of the ending inventory will result in understatement of the cost of goods sold to the same extent. Consequently the operating profit will be overstated to the same extent.