CFA Practice Question

There are 520 practice questions for this study session.

CFA Practice Question

Ending inventory is overstated in Period A. Which of the following occurred as a result of this error?
A. Retained Earnings at the end of Period A is understated.
B. Retained Earnings at the end of Period B is overstated.
C. Retained Earnings at the end of Period B is correct.
Explanation: The Retained Earnings balance of Period B will be correct. The Period A error caused the net income of Period A to be overstated; therefore, the income of Period B is understated by that same amount. The Retained Earnings balance will be correct at the end of period B.

User Contributed Comments 7

User Comment
Bibhu From where Period B comes from? the next period right after period A, I assume.
clarelau Retained earning in Period B are not affected but NI is understated, as EI of period A is BI of period B
soorajiyer Understand Period A NI is inflated. But how does that mean Period B NI would reduced by the same amount is something I need to understand. thanks.
dan1987 I think (C) is referring to total retained earnings for period A and B. Company reports twice a year, the overstatement of retained Earnings in first 6months is corrected by and understatement of the same amount in last 6 months. Therefore the year end retained earning are correct

But process of elimination will be get you there as well Period A is over stated and Period B understated which is not there so has to be C)
Fardeen The ending inventory will become the opening inventory in period B . The ending inventory in period A has an inverse relationship with RE of period A when transfering to Period B it will have a Direct Relationship that it is it will increase the RE to the amount which has been underestated in Period A
Elloyi Period A ending inventory is overstated. Then COGS (Purchases + ending inventory - beginning inventory) in period A is overstated. Therefore NI in period A is understated. Why is NI in period A overstated?
Aastha26 @Elloyi: The formula is Op. Inventory + Purchases = Closing Inv + COGS. So When Closing goes up, COGS goes down, hence better NI for A and an overstated RE for A. This is taken as base for Period B, which leads to understated NI @ Period B and hence correct RE at end of Period B
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