Kuzu Company discovers in 2019 that its ending inventory at December 31, 2018, was $7,000 understated. What effect will this error have on (a) 2018 net income (b) 2019 net income (c) the combined net income for the 2 years

Kuzu Company

Effect of understatement of ending inventory at December 31, 2018 by $7,000:

a) 2018 net income was understated by $7,000.  It should increase by $7,000

b) 2019 net income was overstated by $7,000.   It should reduce by $7,000.

c) the combined net income for the 2 years: No effect.

Explanation:

When Kuzu's ending inventory at December 31, 2018 was understated, it implies that its net income was also understated by $7,000.  This ending inventory becomes the beginning inventory for 2018. The understatement of the previous year's ending inventory (and net income) will become overstatement of the current year's net income.  However, when the two years are combined, the net income will not be affected as one understatement cancels the other overstatement.

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