inventory impact

Effect of Inventory of Assets, Liabilities and Owner’ Equity
Name
Institutional Affiliation
Question
Companies can determine the effect of ending inventory errors on the balance sheet by using the basic accounting equation: Assets = Liabilities + Owner’s Equity. How would the over or understatement of inventory impact assets, liability and owner’s equity.
Response
Adjusting the inventory errors will affect the basic accounting equation as follows:
a) Effect of overstatement and understatement on the owners’ equity
Overstated inventory means that less stock was sold over the period (Clever, 2017). It, therefore, reduces the costs of goods sold and increases the gross profit. Increased gross profit translates to increased net profit which is added to the owners’ equity (opening). Overstating the inventory thus also increases the owners’ equity owing from the increased net profits added to the business capital.
Understating inventory will, however, have an opposite effect on the owners’ equity. Reduction in inventory increases the costs of goods sold and reduces the gross profit. Reduced gross profit will reduce the net profit resulting in an understated capital as a lesser figure will be added to the opening capital. It thus follows that understating the inventory leads to an understated owners’ capital.
b) Effect of overstatement and understatement on assets
Inventory forms part of the assets in a firm. Overstating the stock has a dire…