If the ending inventory of a firm is overstated by $51,000, by how much and in what direction (overstated or understated) will the firm's operating income be misstated? (Hint: Use the cost of goods sold model, enter hypothetically "correct" data, and then reflect the effects of the ending inventory error and determine the effect on cost of goods sold.)

Solution and Explanation:

Since the inventory is overstated, the firm's operating profit will be misstaed. If the ending inventory is overstated then the cost of goods sold would be less since the Cost of goods sold = the opening Inv + the Purchases - Ending Inv entory

Then it would mean that the Gross Profit (GP) would be higher since the Gross Profit (GP) = Sales - cost of goods sold

If gross profit would be higher then the net income (NI) would be higher.