Question

Assume the prior year ending inventory was understated by $ 50,000 . Explain how this error would affect the prior year and current year pretax income amounts. What would be the effects if the prior year ending inventory were overstated by $ 50,000 instead of understated?

Answer 1

When Prior year ending inventory understated by $ 50,000 :

If the ending inventory of the prior year has been understated then the COGS of the prior year get overstated which ultimately understated Pretax income by the same margin.

Prior year ending inventory is the current year opening inventory,  so when the prior year ending inventory has been understated that means the current year opening inventory is also getting understated.  Which resulted in an understatement of COGS and due to which pretax income of the current year gets overstated by the same margin.  

Total pretax income of the two years = $ (50,000) + $ 50,000 = Nil ( No effect).

The four most commonly used inventory types are Raw Materials, Work in Process (WIP), Finished Goods, Maintenance, Repair, and Overhaul (MRO). Knowing the nature of your inventory will help you manage your inventory better and smarter. Consider a fashion retailer like Zara, which operates seasonally.

Learn more about inventory at

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