Question

Which of the following statements pertaining to inventory errors is correct? Inventory errors have no effect on net income because only the statement of financial position accounts are affected. Inventory errors are irreversible and can only be corrected through a Retained Earnings adjustment.

An error in beginning inventory of one period will have no effect on Retained Earnings at the end of the second period. Inventory errors affect a company's pre-tax cash flow.

Answer 1

Inventory errors do impact a company's net income by affecting the income statement and balance sheet, and they can also affect Retained Earnings if the errors pertain to a prior period. These errors are not irreversible and do not directly affect pre-tax cash flow. Corrective adjustments may involve both balance sheet and income statement accounts.

Step-by-step explanation:

Regarding inventory errors and their impact on financial statements, the correct statement is that inventory errors do have an effect on a company's net income, because they affect both the income statement and the balance sheet. If there is an error in the beginning inventory, it will understate or overstate the cost of goods sold (COGS), which will, in turn, affect the net income for that period. Moreover, if the error is not corrected in the same period, it will carry over and affect net income in the subsequent period as well. This happens because the ending inventory for one period becomes the beginning inventory for the next period. As for the Retained Earnings, an error in the inventory will indeed affect this account but only if the error pertains to a prior period and the financial statements for that period have already been issued. In such a case, a prior period adjustment to Retained Earnings is required to correct the error. Inventory errors do not directly affect a company's pre-tax cash flow, as cash flow is concerned with actual transactions rather than accounting valuations. Correcting inventory errors often involves making adjustments to both balance sheet and income statement accounts and is not irreversible; they can be corrected once identified.

Answer 2

Inventory errors can affect net income and Retained Earnings, are not irreversible, and do not directly affect pre-tax cash flow.

Step-by-step explanation:

The question asks which statement pertaining to inventory errors is correct. Addressing each claim: Inventory errors can indeed affect net income, both current and future periods, because any mistake in inventory will alter the cost of goods sold (COGS), which is reflected in the income statement. Inventory errors are not irreversible; they can be corrected in financial statements of subsequent periods once the error is discovered. Incorrect calculations of beginning inventory will affect Retained Earnings, but the effect may be reversed in the following period when the error is corrected. Lastly, inventory errors do not have a direct effect on pre-tax cash flow, since inventory accounting affects accrual-based earnings rather than cash transactions.