the question is£º

Garson Co. recorded goods in transit purchased F.O.B. shipping point at year end as purchases. The goods were excluded
from ending inventory. What effect does the omission have on Garson's assets and retained earnings at year end?
Retained
    Assets             earnings
a. No effect         Overstated
b. No effect         Understated
c. Understated     No effect
d. Understated     Understated
E x p l a n a t i o n
Choice "d" is correct. Because the goods are in transit, the buyer should have included them in inventory. By not including them, inventory and assets are understated. An understatement of ending inventory results in an overstatement of cost of goods sold, which results in an understatement of net income and retained earnings

i understand about the inventory and assets are understated, but i do not understand wether there is a inevitable relationship between the ending inventory (not the real sold inventory) and cost of goods sold.

Than you~

Ending Inventory with $100 Excluded					Ending Inventory with $100 Included
Inventory		Net Income			Inventory		Net Income
BB	-	Sales	600		BB	-	Sales	600
Purchases	500	(COGS)	(400)		Purchases	500	(COGS)	(300)
EI	(100)				EI	(200)
COGS	400	Net Income	200		COGS	300	Net Income	300

The problem states the goods were recorded as purchases, but not included in Ending Inventory. Therefore, Cost of Goods Sold would be overstated, resulting in a lower net income which would understate Retained Earnings. If they had not made the entry to record the purchase, there would be no effect on Retained Earnings.