Accounting Error Question, need help?

Question

In 2007 ending Inventory is Overstated by $2200 therefore Net Income will be overtated by $2200. Why this happens???Why net Income overstates?

Answer 1

if ending inventory is overstated that reduces cost of goods sold, which overstates net income.

Answer 2

Net income is sales less cost of goods sold less operating expenses. COGS is beginning inventory plus purchases less ending inventory, so if ending inventory is overstated, gross profit and ultimately net income will be overstated. Let's illustrate this:

Assume the correct figures should be these:
COGS
Beg inventory 100,000
+ Purchases 200,000
- Ending inventory 120,000
So correct COGS is 180,000

Assume ending inventory is now overstated by 2,200
COGS then becomes
Beg inventory 100,000
+ Purchases 200,000
- Ending inventory 122,200
So wrong COGS is 177,800

Assume sales is 500,000
less correct COGS 180,000
Correct Gross profit is 320,000
less op'g exp 100,000
Correct Net income is 220,000

Let's do this again using the wrong COGS
Sales 500,000
less wrong COGS 177,800
Wrong Gross profit is 322,200
less op'g exp 100,000
Wrong Net income is 222,200 (higher than 220,000 by 2,200)

So as you can see, if ending inventory is overstated by 2,200, net income is overstated by 2,200.

Answer 3

This means that the value of stock has been inflated and accordingly the net profit automatically increased. This is not a mistake but this is done for the following purposes:-
1) There is less profit as compared to last year
2) To take more loan from bank against stock
3) To attract shares holder by showing higher profits
4) As the stock was valued at lower rate in previous years
5) To show more earning on shares.

I hope the thing is clear to you.