Determine the effect on a company’s Assets and Net Income from the following transaction: a loss on inventory is recorded as an adjusting entry.

	Assets	Net Income
A	Decreased	Decreased
B	Decreased	No effect
C	Increased	No effect
D	Increased	Increased
E	None of the above

A company discovered in Year 3 that the following inventory errors had occurred:

• Ending Inventory for Year 1 was understated by $5,000.
• Ending Inventory for Year 2 was overstated by $7,000.

Determine the effect those errors would have on the Year 1 and Year 2 financial statements:

1. How do the errors above affect Assets reported on the Year 1 financial statements? Assets would be...
   • a. Overstated by $2,000
   • b. Overstated by $5,000
   • c. Overstated by $7,000
   • d. Understated by $5,000
   • e. Understated by $12,000
2. How do the errors above affect Net Income reported on the Year 1 financial statements? Net income would be...
   • a. Overstated by $2,000
   • b. Overstated by $5,000
   • c. Overstated by $7,000
   • d. Understated by $5,000
   • e. Understated by $12,000
3. How do the errors above affect Assets reported on the Year 2 financial statements? Assets would be...
   • a. No effect on assets
   • b. Overstated by $2,000
   • c. Overstated by $7,000
   • d. Understated by $2,000
   • e. Understated by $7,000
4. How do the errors above affect Net Income and Shareholders’ Equity reported on the Year 2 financial statements? Net Income and Shareholders’ Equity would be...

   	Net Income	Shareholders’ Equity
   A	Understated by $12,000	Understated by $7,000
   B	Overstated by $5,000	No effect
   C	Overstated by $7,000	Overstated by $2,000
   D	Overstated by $7,000	Overstated by $7,000
   E	Overstated by $12,000	Overstated by $7,000