Inventory error overstates 2020 profit and dividend, reverses in 2021

Steps:

• Closing inventory overstated by $10,000 understates 2020 COGS by$10,000, overstating profit by $10,000.
• Dividend = 40% of overstated profit, so overstated by $4,000; net RE effect at 31 Dec 2020 is increase of$4,000 (dividend portion impact).
• Opening inventory 2021 overstated by $10,000 overstates 2021 COGS by$10,000, understating profit by $10,000.
• At 31 Dec 2021, combine understated profit ($10,000 decrease) and extra dividend ($4,000 decrease) for total $14,000 decrease in RE.

Why C is correct:

• Matches net dividend overstatement ($4,000 increase at 2020 end per profit-dividend formula) and combined 2021 reversal plus dividend effects ($14,000 decrease via COGS = opening inventory + purchases – closing inventory).

Why the others are wrong:

• A: Shows decreases for both years, ignoring 2020 profit overstatement.
• B: Reverses signs and inflates 2021 increase, contradicting error reversal.
• D: Overstates 2020 effect as full $10,000 and understates 2021 decrease by netting carryover.

Final answer: C