Choice "C" is correct. Because inventory is a component of current assets, an overstatement of ending inventory will cause current assets to be overstated The income statement effects of an inventory overstatement or understatement can best be seen by analyzing the cost of goods sold formula:
Beginning inventory
+ Purchases
Cost of goods available for sale
- Ending inventory
Cost of goods sold |
Based on this formula, an overstatement of ending inventory will cause an understatement of cost of goods sold, which will result in an overstatement of gross profit (Sales - Cost of goods sold. Choices "b", "d", and "a" are incorrect, per the above explanation.
