A Level Accounting (9706)•9706/11/O/N/21
Explanation
Inventory Overstatement Self-Corrects in Retained Earnings
Steps:
- Overstating closing inventory at 31 May 2020 reduces COGS for 2020 (COGS = opening inventory + purchases - closing inventory), increasing profit and retained earnings by $20,000.
- This overstated amount carries forward as opening inventory for the year ending 31 May 2021.
- Opening inventory overstatement increases COGS for 2021 by 20,000.
- Retained earnings at 31 May 2021 thus reflect overstated prior RE offset by understated current profit, resulting in no net effect.
Why A is correct:
- Per the COGS formula, inventory errors self-correct over two periods as the overstatement reverses in the next year's calculation.
Why the others are wrong:
- B: Reverses the 2020 overstatement effect on RE.
- C: Reverses both 2020 and 2021 effects.
- D: Correctly identifies 2020 overstatement but incorrectly states 2021 understatement instead of no net effect.
Final answer: A
Topic: Preparation of financial statements
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