Final answer:
If the beginning inventory is overstated, it would lead to an overstatement of the current ratio and an understatement of the cost of goods sold and retained earnings.
Step-by-step explanation:
If the beginning inventory is overstated, it means that the value of the inventory at the start of the accounting period is recorded as higher than it actually is. This has several effects on financial statements:
- The current ratio is overstated: The current ratio is a measure of a company's ability to pay its short-term liabilities with its short-term assets. Overstating the beginning inventory would increase the value of the current assets, leading to a higher current ratio.
- Cost of goods sold is understated: Cost of goods sold (COGS) is an expense that represents the direct costs incurred in producing goods for sale. If the beginning inventory is overstated, it would result in a lower COGS, as the value of the ending inventory would be higher.
- Retained earnings is understated: Retained earnings is a component of shareholders' equity that represents the accumulated profits of a company that have not been distributed as dividends. Overstating the beginning inventory would result in lower expenses, leading to lower net income and, subsequently, lower retained earnings.
- Working capital is not directly affected by the overstatement of beginning inventory.