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A company’s beginning inventory for 2005 was overstated by $37,000, and the endinginventory for 2005 was understated by $16,000. The income tax rate for the company is 30%.These errors will cause the 2006 net income to bea. Understated by $11,200.b. Understated by $25,900.c. Overstated by $11,200.d. Overstated by $25,900.

Question

A company’s beginning inventory for 2005 was overstated by $37,000, and the ending
inventory for 2005 was understated by $16,000. The income tax rate for the company is 30%.
These errors will cause the 2006 net income to be
a. Understated by $11,200.
b. Understated by $25,900.
c. Overstated by $11,200.
d. Overstated by $25,900.

check_circleAnswer
Step 1

The error in valuation of begining Inventory of 2005 will not be having an effect on net income of the year-2006.

However, the error in valuation of ending inventory of 2005 will have an effect on the net income of Year-2006, as it becomes the begining inventory of Year-2006.

Thus when Ending Inventory of 2005 is understated, it means the begining inventory of 2006 is also understated. 

This means the cost of goods sold is also understated (as cost of goods sold is sum total of begining inventory and purchases lee ending inventory). This means the effect of error on net income of the Year-2006 is that the net income has been shown with overstated amount.

Step 2

However, as the net income has been overtstated by $ 16000 in Year  -2006, the tax expense has also risen which is at the rate of 30% i.e. $ 16000*30% =4800. This had r...

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