If an accountant fails to write down obsolete inventory to its current fair market value, what effect does this have on the current ratio?

• A. The current ratio will not be affected.
• B. It is impossible to determine.
• C. The current ratio will be artificially inflated.
• D. The current ratio will be artificially deflated.

Answer: (C)

Not writing down obsolete inventory keeps current assets overstated. The current ratio is current assets divided by current liabilities, so when the numerator is inflated while liabilities stay the same, the ratio increases. For example, if current assets are 200,000 with inventory at 50,000 and current liabilities are 100,000, the ratio is 2.0. If the write-down would reduce inventory to its net realizable value by 10,000, current assets drop to 190,000 and the ratio becomes 1.9. Since only assets are overstated, the ratio appears higher than it truly is. Therefore the current ratio is artificially inflated.