What is the effect of an overstated ending inventory on net income in 2023 and 2024?
An overstatement of ending inventory in 2023 will result in an overstatement of net income in that year. In 2024, the effect will be reversed, leading to an understatement of net income.
Understanding the Impact of Overstated Ending Inventory on Net Income
Ending Inventory and its Significance:
Ending inventory plays a crucial role in determining the cost of goods sold (COGS) and, in turn, the net income of a business. It represents the value of unsold goods at the end of an accounting period.
Impact on Net Income in 2023:
When ending inventory is overstated in 2023, it means that the reported value of inventory on hand is higher than the actual value. As a result, the cost of goods sold is understated, leading to a lower expense and ultimately inflating the net income for that year. This overstatement has a positive impact on net income in 2023.
Impact on Net Income in 2024:
In the following year, 2024, the effects of the overstatement in 2023 start to unwind. The overstatement of ending inventory leads to an understatement of beginning inventory in 2024. Consequently, the cost of goods sold will be higher, resulting in a lower net income for the year.
Overall Impact:
While the overstatement of ending inventory provides a temporary boost to net income in 2023, it ultimately has a negative impact on net income in 2024 as the error is corrected. It is essential for businesses to accurately report ending inventory to ensure the integrity of financial statements and avoid misleading stakeholders.