Errors in inventory valuation distort income statement figures (COGS, gross profit, net income) and carry over to the next year:
If ending inventory is understated by $10,000 (e.g., missed items in count), COGS is overstated by $10,000, reducing gross profit and net income by the same amount in the current year. Next year, beginning inventory is understated, lowering COGS and overstating profit, counterbalancing the error over two years.
If overstated by $10,000, COGS is understated, inflating current-year profit. Next year, higher beginning inventory increases COGS, reducing profit, reversing the effect.
Errors affect trends (e.g., profit appears to drop then rise), mislead stakeholders, and alter owners’ equity (understated or overstated in year 1, corrected by year 2). Exhibit 8-9 shows U (understated), O (overstated), or NE (no effect) across years, emphasizing the self-correcting nature over time, though immediate distortions remain significant.