Harper Corporation Overstated Its Ending Inventory By $3,500 On December 31, 2020. It Did Not Correct The Error In 2020 Or In 2021. As A Result, Harper Corporation’s Stockholders’ Equity Was

The correct option of this multiple choice (mcq) is (b), as when the ending inventory (closing stock) was overstated, the Net Income was overstated and cost of sales was understated by $3,500, as closing inventory is deducted from opening inventory plus inventory purchases, in Income Statement for the accounting year 2020.

As the net income was overstated by $3,500 so retained earnings increased by $3,500 which also increased the shareholders' equity by $3,500. So, due to the overstating value of ending inventory by $3,500, the shareholders’ equity also overstated by $3,500 on the balance sheet as on 12/31/2020.

It is also to be noted that Working Capital (Current Assets minus Current Liabilities) and Current Ratio  (Current Assets / Current Liabilities) also overstated during the period in which the error was made.

In the accounting year 2021, the ending inventory of accounting year 2020, became the opening or beginning inventory, which cancelled each other effect. The cost of sales (cost of goods sold) was overstated, as the beginning inventory is added to purchases in income statement, and net income (net profit) was understated by $3,500, which was previously overstated by $3,500, so it offset / cancel the error, which was previously occurred in accounting year 2020, automatically in accounting year 2021. Due to this offsetting of error, both assets and shareholders’ equity were properly stated at 12/31/2021.

After the occurrence of this error, now the Financial Statements (Income Statement, Balance Sheet, Statement of Shareholders’ Equity And Statements Of Cash Flows) of accounting year 2020 don’t present accurate and reliable accounting information to the users (both internal and external, e.g., owners, management, employees, shareholders, customers, government, law making agencies, etc.). So, the Harper Corporation needs to rectify error occurred in 2020 in order to give accurate, reliable, true and fair view of financial statements to the users of financial statements.

The other options (a, c and) of this mcq are incorrect choices here.