CFA Practice Question

There are 520 practice questions for this study session.

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.
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