What is the effect of inventory overstatement on net income in 2023 and 2024?
The effect of inventory overstatement on net income in 2023 and 2024 is: b. Net income is understated in 2023 and overstated in 2024.
Understanding the Impact of Inventory Overstatement on Net Income
In accounting, the overstatement of ending inventory can have significant effects on a company's financial statements, particularly on the calculation of net income. Let's explore how this error impacts the net income for the years 2023 and 2024.
Effect on Net Income in 2023:
When ending inventory is overstated in a given year, it leads to an understatement of the cost of goods sold (COGS) for that year. Since net income is calculated by deducting COGS from revenue, an understatement of COGS results in an overstatement of net income. Therefore, in 2023, the net income will be overstated due to the lower COGS resulting from the inventory overstatement.
Effect on Net Income in 2024:
The overstatement of ending inventory from 2023 carries over to become the beginning inventory for 2024. As a result, the COGS for 2024 will be overstated, leading to an understatement of net income for that year. This error causes a reversal of the effect seen in 2023, where the net income was overstated due to inventory overstatement.
In summary, the impact of inventory overstatement is asymmetric between 2023 and 2024. While net income is overstated in 2023, it is subsequently understated in 2024 as the effects of the error unfold over the two accounting periods.
Final Note:
It is crucial for companies to ensure the accuracy of their inventory records to avoid misstatements in their financial statements, which can mislead investors and other stakeholders. Proper inventory management and regular reconciliations are essential to prevent errors like inventory overstatement from impacting the company's financial performance.