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:
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