The question asks:

If the market value of inventory is greater than its cost, then the application of the lower-of-cost-or-market rule would
Answer
1. decrease both the current ratio and net income.
2. decrease the current ratio but not change net income.
3. not change the current ratio but decrease net income.
4. change neither the current ratio nor net income.

I know that when market value of inventory is greater than cost, the the inventory account is credited and there is a loss for decline in the market. Also there is a reduction in income so I believe that either 1 or 3 is the answer. However I am having trouble understanding how the current ratio (assets/liabilites) will play a role since those numbers can vary item by item.

morgaine300

First, I guess we're making the assumption that prior to this point in time it was already listed at market and had to be reduced to cost. The problem is not specific about that (unless there's missing information). If it was already at cost prior to this point in time, then it would simply stay at cost and nothing would change.

You don't need to know individual items. Current ratio contains total current assets. Inventory is a current asset, so the total goes down. What would that do to the current ratio? (This is based on the assumption we're changing from market back to cost.)