The understatement of the ending inventory balance causes:

An understatement of the ending inventory balance can have several effects on a company's financial statements. Here's a breakdown of the implications:

Step 1: Define the Problem

Identify the impact of an understated ending inventory on financial statements.

Step 2: Break Down the Problem

1. Cost of Goods Sold (COGS): Understand how ending inventory affects COGS.
2. Net Income: Determine the effect on net income.
3. Balance Sheet: Analyze the impact on the balance sheet.
4. Tax Implications: Consider the tax consequences.

Step 3: Apply Relevant Concepts

• COGS Calculation: COGS = Beginning Inventory + Purchases - Ending Inventory
• Net Income Calculation: Net Income = Revenue - COGS - Expenses
• Balance Sheet Equation: Assets = Liabilities + Equity

Step 4: Analysis, Verify and Summarize

1. COGS Impact: An understated ending inventory increases COGS because it reduces the inventory available for sale. This is because COGS is calculated by subtracting ending inventory from the sum of beginning inventory and purchases.

2. Net Income Impact: Higher COGS leads to lower net income, as net income is calculated by subtracting COGS and other expenses from revenue.

3. Balance Sheet Impact: The understatement of ending inventory results in lower reported assets on the balance sheet, as inventory is a component of current assets.

4. Tax Implications: Lower net income may result in lower taxable income, potentially reducing tax liabilities.

Final Answer

An understatement of the ending inventory balance causes:

• Increased Cost of Goods Sold (COGS)
• Decreased Net Income
• Understated Assets on the Balance Sheet
• Potentially Lower Tax Liabilities