Merchandise inventory at the end of the year was inadvertently overstated. Which of the following statements correctly states the effect of the error on net income, assets, and owner's equity? 1. net income is overstated, assets are overstated, owner's equity is understated 2. net income is overstated, assets are overstated, owner's equity is overstated 3. net income is understated, assets are understated, owner's equity is understated 4. net income is understated, assets are understated, owner's equity is overstated

2. net income is overstated, assets are overstated, owner's equity is overstated

Explanation:

Overstatement in at the year end Merchandise Inventory effects the Net Income and Assets. The calculation of Cost of Goods Sold uses the Closing Inventory, as closing inventory is higher the net cost of goods sold is lower and this will overstate the gross income, Net income and ultimately owner's equity. On the other hand The closing inventory is also reported in the balance sheet as an asset in the current asset section. Overstatement in it will increase in total assets to be reported. So, appropriate answer is 2. net income is overstated, assets are overstated, owner's equity is overstated.

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