Question

After preparing the draft financial statements, it was discovered that stocks costing $15,000 were double-counted. Which of the following statements describes the effects of the error?

1. Net profit will be overstated by $15,000.
2. Liabilities and Owner's Equity will be not be affected.

1) Statement 1

2) Statement 2

3) Both statements

4) None of the statements

Answer 1

Answer)Option 1 that is Net profit will be overstated by $15,000

Impact on Income statement

If the closing stock is overvalued then cost of good sold will reduce and normally in income statement the credit side will increase which will result in increase in gross profit and increase in net profit.In the same manner next year opening stock will be higher resulting an increase in debit side which inturn reduce the gross profit and net profit.

Impacts are simply shown in this table,

When inventory error	Cost of good sold	Net profit
Understate begining invetory	Understated	Overstated
overstate begining invetory	Overstated	Understated
Understate closing inventory	Overstated	Understated
Overstate closing inventory	Understated	Overstated

Impact on Balance sheet

Overvaluation of closing inventory will increase the asset side and won't affect the liability but the owners equity will be overstated.So it will affect owners equity although it is not affecting liability side.

Impacts are simply shown in this table,

Ending inventory error	Asset	Liability	Stake holders equity
Overstated	Overstated	No effect	Overstated
Understated	Understated	No effect	Understated

Hope you understood.Thank you