During the year 2011-2012, the value of closing inventory was overstated by 25,000. Which of the following is true?
AThe cost of goods sold was understated during 2011-2012 but retained earnings will not be affected during 2012-2013
BThe income was overstated during 2011-12 and closing inventory will be overstated during 2012-2013
CThe retained earnings was overstated during 2011-2012 and retained earnings will be understated during 2012-2013
DThe cost of goods sold was overstated during 2011-2012 and income will be understated during 2012-2013
Correct answer
C. The retained earnings was overstated during 2011-2012 and retained earnings will be understated during 2012-2013
Explanation
Closing Stock‘s overstatement increases the profit of the current period and results in the increase of retained earnings relating to the current accounting period. It decreases the profit and thereby retained earnings of the next accounting period since the closing stock of the current accounting period becomes the opening stock of the next accounting period, the overstatement of which has the effect of decreasing the profits and retained earnings.