CFA Practice Question

There are 520 practice questions for this study session.

CFA Practice Question

Which statement(s) is (are) true?

I. Merchandise shipped FOB destination is actually owned by the seller until the goods reach the receiving dock of the buyer.

II. If the ending inventory of a business is understated, the net income for the period will be understated and the retained earnings for the period will be overstated.

III. If the ending inventory of a business is overstated, the net income for the period will be overstated and the net income for the following period will also be overstated.

IV. When the value of ending merchandise inventory is overstated, the net income of the subsequent year will be understated by the amount of the overstatement.
A. I and III
B. I and IV
C. II and III
Explanation: I. Merchandise shipped "FOB shipping point" becomes the property of the buyer as soon as the goods leave the shipping point of the seller.

II. If the ending inventory is understated, the cost of goods sold will be overstated and the net income for the same period will be understated. The retained earnings however, will be understated, because understated net income for the period will be closed to the retained earnings account.

III. When ending inventory is overstated, the net income of the period will also be overstated. With ending inventory becoming the beginning inventory of the subsequent period, this error will cause the net income of the following period to be understated.

IV. The overstated ending inventory will become the beginning inventory of the subsequent year, overstating the cost of merchandise available for sale and the cost of goods sold for the subsequent year, and understating net income.

User Contributed Comments 8

User Comment
kalps Note that this specifies FOB destination !!!!!
photoshop Why item I is correct?
min photoshop:

the explanation clearly states that under 'FOB shipping point' (not FOB destination ) it will be the property of the buyer.
Pooh I don't understand III. Why would the error cause the net income of the following period to be UNDERSTATED, instead of overstated? End Inventory = Beg Inv+purchase-COGS. Can someone show how does the formula changes to affect net income?
johnsk Net income = Sales - COGS - other expenses. If ending inventory is overstated, then COGS is understated and the NI for that period is overstated. For the following period, the overstated ending inventory becomes overstated beginning inventory, and the COGS for the following period will be overstated, causing the NI for that period to be understated.
yanpz I don't think IV is correct because the inventory will affect Pretax income, then the net income of subsequent year is understated, but not the exact amount of overstatement of Beginning Inventory.
migena For the subsequent period:
EI0 at t0 was overstated => BI1 at t1 overstated
=> COGS1 at t1 = (overstated)BI1 - EI1 + P

Assume constant purchases, hence just by an overstated BI1 = EI0, COGS1, i.e. COGS in the subsequent period, is overstated, leaving an understated NI1, i.e. NI at t1, in the subsequent period.
tomalot WTF is FOB?
You need to log in first to add your comment.