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Impact to Net Income When Inventory Is Understated?

A common topic on the CPA exam that FAR candidates typically struggle with is what the impact to net income or retained earnings would be when the company understates the ending inventory balance. If the company uses the periodic method to account for inventory, then at the end of the year, they would perform their physical inventory count to determine the ending inventory balance. They would then use the inventory rollforward or BASE method to determine what cost of goods sold for the year would be.

The Excel template below illustrates the impact to the income statement and balance sheet when we make an adjustment to increase inventory because the inventory balance was previously understated. The video below is a walkthrough of how you should approach this type of topic!


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