Merchandise inventory at the end of the year was inadvertently overstated. Which of the following statements correctly states the effect of the error on net income, assets, and owner's equity?

A) Net income is overstated, assets are overstated, and owner's equity is understated.
B) Net income is overstated, assets are overstated, and owner's equity is overstated.
C) Net income is understated, assets are understated, and owner's equity is understated.
D) Net income is understated, assets are understated, and owner's equity is overstated.

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Jennifer Khalil · Accepted Answer

Final Answer : B, Explanation :  Overstating ending inventory leads to an overstatement of net income because cost of goods sold is understated. This also results in assets being overstated on the balance sheet. Since net income flows into retained earnings, a component of owner's equity, owner's equity is also overstated.

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