- CFA Exams
- CFA Level I Exam
- Study Session 8. Financial Reporting and Analysis (3)
- Reading 25. Inventories
- Subject 6. Financial Analysis of Inventories

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**CFA Practice Question**

Assume the correct current ratio is larger than 1. If purchase (on account) is overstated by $3,000 and ending inventory is overstated by $3,000, the current ratio is ______ and working capital is ______.

A. understated; not affected

B. not affected; overstated

C. overstated; not affected

**Explanation:**EI = BI + purchase - COGS

If both purchase on account and ending inventory are overstated by the same amount, the current ratio will be understated (current ratio = current assets / current liabilities, in which both the numerator and the denominator are overstated - but the ratio will be lowered since it is larger than 1). However, working capital (which equals current assets - current liability) should be unaffected.

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**User Contributed Comments**
8

User |
Comment |
---|---|

geet |
A/P |

nchilds |
purchases on accounts = a/p (CL) |

lazio |
tough question... |

sheenalim |
i don't get the explanation. if purchase on account increase by 3k then A/P increase by 3k. If ending inventory increase by 3k then asset increase by 3k. since current ratio is current assets/current liabilities both numerator and denominator will increase by same amt so the ratio doesn't change. what am i missing here? |

sheenalim |
oh i get it. both denominator and numerator will increase by 3000, but the ratio will nevertheless be pulled down. dunno why though. |

doriva |
CA=200; CL=100; change in both by 3 CR=200/100=2 CR=203/103=1.97 |

najat |
sheenalim, this is because the ratio CA/CL is >1 |

MohitSeth1976 |
Assume CA-5000 in which INVENTORY is 3000 assume CL -4000 in which A/c Payable is 3000 Current ratio would be 1.25. (here both Inv. and A/c payable is overtstated by 3000): Working capital is CA-CL = 5000-4000=1000. Let's correct it which means inventory is 0 and A/c P is 0 too then current ratio would be =2000/1000=2 and working capital =2000-1000=1000. This shows that current ratio was understated(1.25) and working capital was unaffected. |