Q. Valuation of ending inventory?

First a merchandising company should be sure that it has properly valued its ending inventory. If the resulting in an ending inventory is overstated, overstatement of gross margin, cost of goods sold is understated and net income. As well overstatement of ending inventory causes total assets, current assets and retained earnings to be overstated. Therefore any change in the calculation of ending inventory is reflected, in net income, dollar for dollar (ignoring any income tax effects), current assets, total assets and retained earnings.

Second when a company wrongly entered its ending inventory in the current year the company carries forward that misstatement into the next year. This misstatement takes place because the ending inventory amount of the current year is the beginning inventory amount for the next year.

Third one, an error in one periods ending inventory automatically create an error in net income in the opposite direction in the next period. Subsequent to two years however the error washes out and assets and retained earnings are properly stated.