- CFA Exams
- CFA Level I Exam
- Topic 3. Financial Statement Analysis
- Learning Module 22. Inventories
- Subject 6. Financial Analysis of Inventories

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**CFA Practice Question**

If ending inventory is understated by $2,000 and beginning inventory is overstated by $3,000, net income will be ______

A. understated by $5,000.

B. overstated by $1,000.

C. overstated by $5,000.

**Explanation:**COGS = BI + Purchase - EI

If BI is higher, COGS is higher.

If EI is lower, COGS is higher.

Based on this relationship, COGS is overstated by $2,000 + $3,000.

Net income is understated by $5,000.

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**User Contributed Comments**
5

User |
Comment |
---|---|

copus |
I think there is a mistake in the answer to this question. Assume the following: 5,000 (BI) + 5,000 (Purchases) - 5,000 (EI) BI is understated by 2,000. It should be 7,000. EI is overstated by 3,000. It should be 2,000. COGS therefore = 7,000 + 5,000 - 2,000 = 10,000 In other words, COGS is 5,000 but it should be 10,000 meaning that it is UNDERSTATED by 5,000 and NOT OVERSTATED. If your COGS is understated, that means that your Net Income is overstated by 5,000. ....or am I missing something?? |

chbourke |
yes you did missed something: BI is overstated and EI is understated. You did the opposite. |

HectorRS2 |
cogs:+3+0-(-2) |

Profache |
If BI =5,000, Purchases = 10,000 and EI= 3,000, then Actual CGS = 5,000+10,000-3,000 = 12,000 Correct CGS = 2,000+ 10,000 -5,000 = 7,000 The actual CGS is overstated by 5,000,causing the net income to be lower (understated) by 5,000 |

kingirm |
100 + no purchase - 100 = 0 cogs 103 + no purchase - 98 = +5 cogs so the income will be 5 understaded (minus 5) |