If a Company Understates Its Inventory, What Are the Effects

question 4

Multiple Choice

If a company understates its inventory, what are the effects on cost of goods sold and net income for the current year?

• A)Cost of goods sold will be understated and net income will be overstated.
• B)Cost of goods sold will be overstated and net income will be understated.
• C)Both cost of goods sold and net income will be understated.
• D)Both cost of goods sold and net income will be overstated.

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Definitions:

Absorption Costing

An accounting method that includes all of the direct and indirect manufacturing costs in the cost of a product.

Product Cost

The total expenses incurred to create a product, including direct labor, materials, and overhead costs.

Variable Costing

An accounting method that includes only variable production costs—direct materials, direct labor, and variable manufacturing overhead—in the cost of goods sold, treating fixed manufacturing costs as period costs.

Fixed Overhead

The set of expenses that do not vary with the level of production or sales, such as rent, salaries, and insurance.