Certified Internal Auditor (CIA) Part 3: Business Knowledge for Internal Auditing — Question 35

A retail organization mistakenly did not include $10,000 of inventory in the physical count at the end of the year. What was the impact to the organization's financial statements?

Answer options

• A. Cost of sales and net income are understated.
• B. Cost of sales and net income are overstated.
• C. Cost of sales is understated and net income is overstated.
• D. Cost of sales is overstated and net income is understated.

Correct answer: A

Explanation

When inventory is not included in the physical count, it leads to a lower cost of sales because the cost of unsold inventory is not accounted for. This, in turn, results in an overstated net income since expenses are lower than they should be, making option A the correct choice. The other options incorrectly describe the relationship between cost of sales and net income based on the missing inventory.