ICAEW AF · Chapter 9 · Question 7 of 9
A business overstated its closing inventory at the end of year 1. The error was not discovered and the year 2 closing inventory was correct. What is the effect on reported profits?
Test yourself: pick an answer
Reveal answer & explanation
Correct answer: A) Year 1 profit is overstated and year 2 profit is understated
Explanation
Overstating closing inventory reduces cost of sales, so year 1 profit is overstated. Year 1 closing inventory becomes year 2 opening inventory, which increases year 2 cost of sales and understates year 2 profit by the same amount. Over the two years combined, the error reverses.
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