During the year-end closing process, a firm discovered that the prior year's ending inventory was overstated by 50,000. Consequently,
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Answer: C. Previous year‘s profit is overstated and current year‘s profit is understated.
Explanation
An overstatement of ending inventory in the prior year overstates that year's profit while understating the current year's profit due to cost of goods sold effects. Ending inventory becomes the next period's beginning inventory. This creates an inverse impact on the subsequent year's cost of goods sold and net income. Inventory valuation directly impacts the calculation of cost of goods sold. Overstating ending inventory reduces cost of goods sold, thus inflating gross profit. In the following year, an inflated beginning inventory increases cost of goods sold, reducing profit.
Accurate physical inventory counts are vital for multi-year profit analysis. Auditors review inventory cut-off procedures to prevent timing errors. Cross-period inventory mistakes self-correct over two accounting cycles. Previous year profits change due to altered cost of goods sold calculations. Current year profits change because beginning inventory sets baseline costs. Assuming no impact ignores the mathematical link between consecutive inventory periods.
- Subject
- Accounting and Finance
- Category
- Accounting
- Topic
- —
- Difficulty
- medium
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