Your Ask Joey ™ Answer

If cost of goods sold are understated, then is net income overstated or understated?

If cost of goods sold are understated, then net income would be overstated (inverse relationship). As you can see, if cost of good sold should have been $100 instead of $75, then net income should be $75 and not $100 (assuming no impact to operating expense.

Since there is an inverse relationship, that means net income would be understated if cost of goods sold are overstated.


Back To All Questions

You might also be interested in...

  • If ending inventory is overstated, would cost of goods sold be overstated or understated?

    If ending inventory is overstated, then cost of goods sold would be understated. As you can see in the visual below, the incorrectly stated inventory balance is $25 higher than the correct ending inventory balance. Since we can assume that beginning inventory and purchases would be the same, the difference would impact cost of good sold. Inventory and cost of goods sold are inversely related, so if inventory is overstated, cost of goods sold would be understated.  Below is the related income statement that shows the impact from overstating inventory. As you can see, cost of goods would be overstated which understates gross profit and net income. Below is an example multiple choice explanation video that provides further explanation:

  • If ending inventory is overstated, would net income be overstated or understated?

    If ending inventory is overstated, then cost of goods sold would be understated. As you can see in the visual below, the incorrectly stated inventory balance is $25 higher than the correct ending inventory balance. Since we can assume that beginning inventory and purchases would be the same, the difference would impact cost of goods sold. Inventory and cost of goods sold are inversely related, so if inventory is overstated, cost of goods sold would be understated.  So now that we know cost of goods sold is understated, you can see how that impacts the income statement in the visual below. When cost of goods sold is understated, gross profit is overstated, and net income is overstated (as well as retained earnings).