Audit and Assurance Practice Exam

Question: 1 / 400

Which concern regarding inventory could lead to higher net income?

Purchases being understated.

Ending inventory being understated.

Purchases being properly reported.

Ending inventory being overstated.

Choosing the option that refers to ending inventory being overstated is correct because higher ending inventory directly affects the cost of goods sold (COGS) calculation. When ending inventory is reported as higher than it actually is, it leads to a lower cost of goods sold. Since net income is calculated as sales revenue minus COGS, a lower COGS means higher net income.

In contrast, if ending inventory is understated, it would increase COGS and reduce net income. Properly reported purchases would not necessarily have an immediate effect on net income; they must be considered in relation to inventory levels for impact. Understating purchases does not inherently lead to higher net income either, as it could misrepresent both inventory and expenses. Thus, overstating ending inventory is the only situation listed that will lead to a direct increase in net income.

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