Many companies have to monitor closely certain ratios, such as the current ratio, due to debt covenants. Selected transactions are provided below for a company that uses a perpetual inventory system; sells its merchandise at a selling price that exceeds cost; and had a current ratio of 1.85 and a quick ratio of 1.19 before the event occurred.
Required:In the above table, indicate whether each transaction would increase (+), decrease (?), or not affect (0) the company's current ratio and quick ratio.
What will be an ideal response?
Answers will vary
Current ratio = Current assets ÷ Current liabilities
Quick ratio = Quick assets (which include cash, accounts receivable, and current marketable securities) ÷ Current liabilities
Impact of each transaction on these components:
1. No change in current assets or quick assets (since increase in cash equals decrease in accounts receivable) and no change in current liabilities
2. Increase in current assets (cash) and quick assets (cash) and no change in current liabilities
3. No change in current assets (since decrease in cash equals increase in prepaid insurance), increase in quick assets (cash) and no change in current liabilities
4. Decrease in current assets (cash), decrease in quick assets (cash), and decrease in current liabilities (dividends payable).
To determine the impact on the current ratio, assume that the current ratio of 1.85 to 1 meant that current assets were $185,000 and current liabilities were $100,000 and the dividend payment was for $10,000. The new current ratio would then equal ($185,000 ? $10,000) ÷ ($100,000 ? $10,000) = $175,000 ÷ $90,000 = 1.94 (which is an increase from 1.85 to 1).
To determine the impact on the quick ratio, assume that the quick ratio of 1.19 to 1 meant that current assets were $119,000 and current liabilities were $100,000 and the dividend payment was for $10,000. The new quick ratio would then equal ($119,000 ? $10,000) ÷ ($100,000 ? $10,000) = $109,000 ÷ $90,000 = 1.21 (which is an increase from 1.19 to 1).
5. Decrease in current assets (cash) and decrease in current liabilities (accounts payable)
To determine the impact on the quick ratio, assume that the quick ratio of 1.19 to 1 meant that current assets were $119,000 and current liabilities were $100,000 and the payment on account was for $10,000. The new quick ratio would then equal ($119,000 ? $10,000) ÷ ($100,000 ? $10,000) = $109,000 ÷ $90,000 = 1.21 (which is an increase from 1.19 to 1).
6. No change in current assets or current liabilities
7. Increase in current assets (inventory) and increase in current liabilities (accounts payable)
To determine the impact on the current ratio, assume that the current ratio of 1.85 to 1 meant that current assets were $185,000 and current liabilities were $100,000 and the purchase of inventory on account was for $10,000. The new quick ratio would then equal ($185,000 + $10,000) ÷ ($100,000 + $10,000) = $195,000 ÷ $110,000 = 1.77 (a decrease from 1.85 to 1).
To determine the impact on the quick ratio, assume that the quick ratio of 1.19 to 1 meant that current assets were $119,000 and current liabilities were $100,000 and the purchase of inventory on account was for $10,000. The new quick ratio would then equal ($119,000 + 10,000) ÷ ($100,000 + $10,000) = $129,000 ÷ $110,000 = 1.1 (which is a decrease from 1.19 to 1).
8. No change in current assets or quick assets (since decrease in cash equals increase in current marketable securities) and no change in current liabilities
14. Increase in current assets and quick assets (since increase in cash exceeds decrease in inventory) and no change in current liabilities
15. Increase in current assets and quick assets (since increase in account receivable exceeds decrease in inventory) and no change in current liabilities
You might also like to view...
Select the most accurate statement about culture
A) Culture is a subject that is usually taught in high school. B) Cultural attitudes are not learned until adulthood. C) Culture is not something we can be taught; it's something we possess at birth. D) Cultural rules of behavior learned from your family and society are conditioned from early childhood.
Voir dire is a process for presenting evidence in a case.
Answer the following statement true (T) or false (F)
Incoterms are published by the International Chambers of Commerce based in Paris, France
Indicate whether the statement is true or false
A time?sharing interest can only be a lease
Indicate whether the statement is true or false