Overstated vs. Understated Inventory

Understated and overstated inventory are common errors in inventory management that can distort a company’s financial statements. These errors are generally identified during a physical inventory count.

When inventory is understated, it means the actual inventory on hand is more than what is recorded.

This leads to a lower value of assets on the balance sheet, a higher cost of goods sold, and a lower net income.

On the other hand, when inventory is overstated, it means that more inventory is recorded than actually exists.

This results in inflated assets, a lower cost of goods sold, and a higher net income, giving a false impression of profitability.

For example, suppose Apex Corporation reports a twenty thousand dollar beginning inventory, sales revenue of one hundred thousand dollars, and eighty thousand dollars in purchases for an accounting period.

With actual ending inventory being fifty thousand dollars, an understated ending inventory of forty thousand dollars will result in higher COGS and lower profits.

On the other hand, if the company reports sixty thousand dollars instead, the COGS is lower, and profits are exaggerated.