Final answer:
An overstated beginning inventory leads to an understated cost of goods sold, overstated retained earnings, and overstated working capital and current ratio in a company's financial statements.
Option 'a' is the correct.
Step-by-step explanation:
When the beginning inventory is overstated, it means that the amount of inventory recorded at the start of the financial period is higher than it should be. This impacts the financial statements in a few different ways:
- The cost of goods sold (COGS) is calculated as Beginning Inventory + Purchases - Ending Inventory. If the beginning inventory is overstated, it inflates the subtracted part of the equation (since the ending inventory of the previous period is the beginning inventory of the next), leading to an understated COGS.
- Retained earnings reflect the cumulative net income of a company that has been retained rather than distributed as dividends. If COGS is understated due to an overstated inventory, net income is overstated, leading to an overstated retained earnings account.
- When beginning inventory is overstated, working capital, which is the difference between current assets and current liabilities, can appear higher than it actually is because inventory is a current asset. Thus, working capital would be overstated, not understated.
- The current ratio, which is a measure of liquidity (current assets divided by current liabilities), would also be overstated because an overstated beginning inventory inflates current assets.
Therefore, the correct response to the question is that if the beginning inventory is overstated, cost of goods sold is understated, retained earnings is overstated, working capital is overstated, and the current ratio is overstated.