If inventory is understated at the end of the year, what is the effect on net income?

If inventory is understated at the end of the year, the net income for the year is also understated.

Here’s a brief explanation. If a company has a cost of goods available of $100,000 and it assigns too little of that cost to inventory, then too much of that cost will appear on the income statement as the cost of goods sold. Too much cost on the income statement will mean too little net income.

Another way to view this is through the accounting equation, Assets = Liabilities + Owner’s Equity. If you assign too little of the cost of goods available to Assets, then the amount of Owner’s Equity will be too little—caused by net income being too little.

Learn more about Inventory and Cost of Goods Sold.

AccountingCoach.com also has crossword and word scramble puzzles on inventory and cost of goods sold. 

About the Author: Harold Averkamp (CPA) has worked as an accountant, consultant, and university accounting instructor for more than 25 years.

He is the author of the 2010 Master Accounting Download Package which has been praised for it's ability to simplify accounting in a way that anybody can understand.