What is the effect of an overstatement of ending inventory on the financial statements?

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Q: What is the effect of an overstatement of ending inventory on the financial statements?

Solution: An overstatement of ending inventory leads to an understatement of cost of goods sold, resulting in overstated net income.

Steps: 6

Step 1: Understand what ending inventory is. Ending inventory is the value of goods that a company has at the end of a period.
Step 2: Know that cost of goods sold (COGS) is the total cost of producing or purchasing the goods that were sold during a period.
Step 3: Realize that if ending inventory is overstated, it means the company thinks it has more goods than it actually does.
Step 4: When ending inventory is overstated, COGS is calculated as lower because COGS = Beginning Inventory + Purchases - Ending Inventory.
Step 5: Since COGS is lower, this means that the expenses are lower, which leads to higher net income.
Step 6: Understand that overstated net income can mislead investors and stakeholders about the company's actual financial health.