Question

What is the effect of a $40500 overstatement of last year's inventory on current years ending retained earning balance?

A) Need more information to determine

B) Overstated by 40500

C) No effect

D) Understated by 40500

Answer 1

Ending inventory was overstated by $40,500 in the last year.

Due to overstated ending inventory in the last year, net income and retained earnings were overstated.

Ending inventory of the last year will become the beginning inventory of the current year. Due to overstated beginning inventory in the current year, cost of goods sold will be overstated and thus, net income will be understated.

Thus, overstated retained earnings in the last year will get corrected in the current year.

Thus, in the current year, there will be no effect in retained earnings.

Correct option is C.