Effects of Overvalued Closing Inventory

Steps:

• Overvalued closing inventory understates COGS in the current year (COGS = opening inventory + purchases - closing inventory).
• Understated COGS overstates gross profit and net profit for the current year.
• Balance sheet assets (inventory) are overstated due to the error.
• Next year's opening inventory is overstated, overstating next year's COGS and understating next year's profit.

Why A is correct:

• A reflects overstated current profit, overstated current assets, and understated next profit, per the inventory-profit relationship in the accounting equation.

Why the others are wrong:

• B and C incorrectly state current profit as understated with no effects on assets or next year.
• D reverses the profit effects, understating current profit and overstating next profit.

Final answer: A