What are the effects of overstating inventory?

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:

The overstating of inventory will also affect the following reported amounts on the corporation's balance sheet:

  • The amount of inventory will be too high
  • The amount of current assets and total assets will be too high
  • Retained earnings and stockholders' equity will be too high
  • 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.)