ExpertMedium2 marksMultiple Choice
ACCA · Question 25 · Analyzing Financial Statements
SECTION B - CASE 2: BioHarvest Agri
BioHarvest Agri Co operates commercial vineyards. The year-end is 30 September 20X6.
If BioHarvest incorrectly valued its closing wine inventory at $150,000 instead of the correct value calculated previously, what would be the impact on the Gross Profit Margin and Current Ratio for the year ended 30 September 20X6?
SECTION B - CASE 2: BioHarvest Agri
BioHarvest Agri Co operates commercial vineyards. The year-end is 30 September 20X6.
If BioHarvest incorrectly valued its closing wine inventory at $150,000 instead of the correct value calculated previously, what would be the impact on the Gross Profit Margin and Current Ratio for the year ended 30 September 20X6?
Answer options:
A.
Gross Profit Margin overstated; Current Ratio understated.
B.
Gross Profit Margin understated; Current Ratio overstated.
C.
Both Gross Profit Margin and Current Ratio would be overstated.
D.
Both Gross Profit Margin and Current Ratio would be understated.
How to approach this question
Trace the impact of overstated closing inventory. 1. Cost of Sales = Opening Inventory + Purchases - Closing Inventory. If Closing Inventory is too high, Cost of Sales is too low. 2. Gross Profit = Sales - Cost of Sales. If Cost of Sales is too low, Gross Profit is too high. 3. Current Ratio = Current Assets / Current Liabilities. If Inventory (a current asset) is too high, the Current Ratio is too high.
Full Answer
C.Both Gross Profit Margin and Current Ratio would be overstated.✓ Correct
Valuing inventory at $150,000 instead of $115,000 means closing inventory is overstated by $35,000. An overstated closing inventory reduces Cost of Sales, which artificially inflates Gross Profit and the Gross Profit Margin. Simultaneously, inventory is a current asset, so overstating it inflates total Current Assets, leading to an overstated Current Ratio.
Common mistakes
Thinking that higher closing inventory increases cost of sales.
Practice the full ACCA FR — Financial Reporting Practice Exam 1
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