Definition of Overstating Inventory
Overstating inventory means that the reported amount for the cost of a company’s inventory is greater than the actual true cost based on accounting rules. In other words, the reported amount is:
- Incorrect
- Too high
- More than it should be
Examples of the Effect of Overstating Inventory
If a corporation overstates its inventory, it will affect the following reported amounts on the corporation’s income statement:
- Cost of goods sold will be too low
- Gross profit will be too high
- Operating income and net income will be too high
- A regular corporation’s income tax expense will be too high
The overstating of inventory will also affect the following reported amounts on the corporation’s balance sheet:
Since the overstated amount of inventory at the end of one accounting period becomes the beginning inventory of the following period, the following period’s cost of goods sold will be too high and will result in the following period’s gross profit and net income being too low. (The retained earnings and other balance sheet amounts will be correct at the end of the second period.)
