Which of the following is not a direct consequence of overstating ending inventory?

• A. Assets overstated
• B. Equity overstated
• C. Liabilities overstated
• D. Cost of goods sold understated

Answer: (C)

Overstating ending inventory inflates assets. Ending inventory sits on the asset side of the balance sheet, so reporting it higher than it really is makes total assets too large. It also affects the cost of goods sold: COGS equals Beginning Inventory plus Purchases minus Ending Inventory, so a higher ending inventory reduces COGS. A lower COGS increases gross profit and, all else equal, net income, which boosts retained earnings and thus equity.

Liabilities aren’t directly changed by misstating ending inventory, so they don’t become overstated as a direct result. The direct consequences you would see are assets overstated and equity overstated, with COGS understated.