Trace an inventory valuation error through profit and assets
Calculate how an incorrect closing inventory value changes cost of sales, gross profit, profit for the year, equity and assets.
Cambridge IGCSE Accounting 0452 / (9–1) 0985, 2027–2029 Version 1. These lessons follow the 2027–2029 syllabus only; the separate 2026 syllabus update is not yet mapped. Written practice is self-checked, not an official Cambridge grade. Full timed-paper practice and human subject-teacher review remain pending.
Before you begin
- No previous accounting study is assumed. Keep the business, transaction and accounting period in view, and distinguish a resource, a claim and a performance result.
Work on paper. Try each question before revealing help, and explain why your method works.
Quick readiness check
How does closing inventory enter the cost-of-sales formula?
What you will learn
- Relate closing inventory to cost of sales
- Calculate the effect of overvaluation or undervaluation
- Explain the effect of an incorrect inventory valuation on gross profit, profit for the year, equity and asset valuation
Closing inventory reduces cost of sales
Cost of sales = opening inventory + net purchases − closing inventory. A higher closing inventory reduces the cost of sales charged to the period and increases gross profit; a lower closing inventory does the reverse.
Closing inventory is also a current asset. With other figures unchanged, overstating it overstates current assets, gross profit, profit for the year and equity by the same amount before tax or other adjustments.
Compare the recorded amount with the correct valuation
If closing inventory is understated, cost of sales is overstated and profit and assets are understated. Correct the figure using lower of cost and NRV and trace the difference through both statements.
An equal and opposite effect can occur in the next period through opening inventory, but do not use next year's effect to excuse a wrong current-year valuation.
Pause and explain
Closing inventory is overstated by $250. Which effect is expected before other adjustments?
Worked example
Closing inventory should be $2,400 but was recorded as $2,050. Calculate the error and its effect on current-year gross profit, profit for the year, assets and equity.
Show the worked solution
- Inventory is understated by 2,400 − 2,050 = $350.
- Cost of sales is overstated by $350 because closing inventory was subtracted by too little.
- Gross profit, profit for the year, current assets and equity are each understated by $350 before other adjustments.
Answer Inventory, gross profit, profit for the year, assets and equity are understated by $350; cost of sales is overstated by $350.
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Test this topic →From guided practice to a new situation
Write your answer and reasoning first. Use a hint only if you are stuck. The model solution is for self-checking; your written work is not automatically marked.
Opening inventory is $3,000 and net purchases are $12,500. Closing inventory should be $2,400 but was recorded at $2,050. Calculate correct and recorded cost of sales.
Give me a hint
Use opening plus net purchases less closing inventory for both values.
Compare my reasoning
- Correct cost of sales = 3,000 + 12,500 − 2,400 = $13,100.
- Recorded cost of sales = 3,000 + 12,500 − 2,050 = $13,450.
- Recorded cost of sales is overstated by $350.
Correct cost of sales $13,100; recorded cost of sales $13,450, overstated by $350.
Look for these in your work
- Correct value calculated
- Recorded value calculated
- Difference explained
Closing inventory is overstated by $600. State the effect on cost of sales, gross profit, profit for the year, current assets and equity before other adjustments.
Give me a hint
Inventory is subtracted in cost of sales and appears as an asset.
Compare my reasoning
- Cost of sales is understated by $600.
- Gross profit and profit for the year are overstated by $600.
- Current assets and equity are also overstated by $600.
Cost of sales understated $600; gross profit, profit for the year, current assets and equity overstated $600.
Look for these in your work
- Cost-of-sales direction correct
- Profit effects correct
- Position effects correct
A shop reduces a damaged product's NRV by $220 when valuing inventory. Explain why this changes both the income statement and statement of financial position.
Give me a hint
The closing inventory figure is used in cost of sales and reported as an asset.
Compare my reasoning
- The $220 write-down increases cost of sales by $220 compared with the unreduced value.
- Gross profit and profit for the year fall by $220, all else equal.
- Inventory and equity fall by $220 in the statement of financial position.
The write-down reduces inventory and equity by $220 and increases cost of sales, reducing gross profit and profit for the year by $220.
Look for these in your work
- Valuation change traced
- Profit effect correct
- Asset/equity effect correct
Common mistakes
- Saying a closing inventory overstatement increases cost of sales
- Changing profit without changing the inventory asset
- Confusing opening inventory with closing inventory
What can you explain now?
Closing inventory is overstated by $500. What happens to current-year cost of sales?
Compare with the explanation
It is understated by $500
Closing inventory is subtracted in the cost-of-sales calculation.
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Make it stick
Why does an incorrect closing inventory value affect both the income statement and statement of financial position?
If you needed the solution, close it and solve the problem again from a blank page. A correct answer is stronger when you can explain the reason for each step.