Question

Subsequent to the development of their 2016 financial statements, Jay Company discovered the following errors:

Ending inventory for 2015 was overstated by $5,000

Ending inventory for 2016 was understated by$7,000

         As a result of the 2 errors, net income for 2016 would be:

	A.	Understated by $7,000
	B.	Understated by $2,000
	C.	Overstated by $2,000
	D.	Overstated by $7,000
	E.	Understated by $12,000

Answer 1

Ending inventory for 2015 means the opening inventory for year 2016. Overstated opening inventory will reduce the net income because we have to subtract opening inventory while arriving at net income.

Ending inventory for 2016 means the closing inventory for year 2016. Understated closing inventory will reduce the net income because we have to add closing inventory while arriving at net income.

So net effect is :

1) if we reduce opening inventory by $5000 then it will increase net income by 5000.

2) if we increase closing inventory by $7000 then it will increase net income by $7000.

So that means because of the errors the net income is understated by $12000.

Correct answer is E) understated by $12000