A company understated its ending inventory balance by $5,000 in 2021. What impact will this error have on total assets and retained earnings in 2021 and 2022 (ignoring tax effects)?

In 2021, Cost of goods sold would be overstated, net income, retained earnings and assets would be understated. All by $5,000.

In 2022,Opening inventory would be understated closing inventory will also be understated by the same amount.

Explanation:

The change in inventory balance in a period is usually due to purchases and sales. The period opening and closing balances are connected as such;

Opening balance + purchases - cost of goods sold = ending balance

Hence understating the ending balance by $5,000 in 2021 would result in an overstatement of cost of goods sold by $5,000 thereby resulting in an understatement of net income by the same amount and retained earning also in the same year.

In 2021, opening inventory balance will be understated hence the ending inventory balance will also be understated.

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