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