A firm has a current ratio greater than 1.0. If the firm's ending inventory is understated by $3,000 and beginning inventory is overstated by $5,000, the firm's net income (before taxes) and current ratio will be: $$\begin{array} { | l | l | l | }
\hline & { \text { Net Income } } & \text { Current Ratio } \
\hline \text { A) } & \text { understated by } \$ 2,000 & \text { too low } \
\hline \text { B) } & \text { overstated by } \$ 2,000 & \text { too low } \
\hline \text { C) } & \text { understated by } \$ 8,000 & \text { too low } \
\hline \text { D) } & \text { understated by } \$ 8,000 & \text { too high } \
\hline
\end{array}$$
A) Option A
B) Option B
C) Option C
D) Option D

Question

A firm has a current ratio greater than 1.0. If the firm's ending inventory is understated by $3,000 and beginning inventory is overstated by $5,000, the firm's net income (before taxes) and current ratio will be: $$\begin{array} { | l | l | l | } 
\hline & { \text { Net Income } } & \text { Current Ratio } \
\hline \text { A) } & \text { understated by } \$ 2,000 & \text { too low } \
\hline \text { B) } & \text { overstated by } \$ 2,000 & \text { too low } \
\hline \text { C) } & \text { understated by } \$ 8,000 & \text { too low } \
\hline \text { D) } & \text { understated by } \$ 8,000 & \text { too high } \
\hline
\end{array}$$
A) Option A
B) Option B
C) Option C
D) Option D

Quizplus · Accepted Answer

The ending inventory understatement of $3,000 will result in a decrease in net income (before taxes) by $3,000, since cost of goods sold will be overstated (cost of goods sold = beginning inventory + purchases - ending inventory). 
The beginning inventory overstatement of $5,000 will result in an increase in net income (before taxes) by $5,000, since cost of goods sold will be understated. 
Therefore, the net income (before taxes) will decrease by $3,000 - $5,000 = $-2,000 (which means it is understated by $2,000). 
Since the current ratio is calculated as current assets divided by current liabilities, it will decrease as well due to the decrease in current assets (inventory) caused by the ending inventory understatement. Therefore, Option C is the best choice.

A Firm Has a Current Ratio Greater Than 1 A) Option a B) Option B C) Option C D)

A Firm Has a Current Ratio Greater Than 1 A) Option a
B) Option B
C) Option C
D)