Windham Company has current assets of $400,000 and current liabilities of $500,000. Windham Company’s current ratio will be increased by
Answer (A) is correct. The current ratio equals current assets divided by current liabilities. An equal increase in both the numerator and denominator of a current ratio less than 1.0 causes the ratio to increase Windham Company’s current ratio is .8 ($400,000 ÷ $500,000). The purchase of $100,000 of inventory on account would increase the current assets to $500,000 and the current liabilities to $600,000, resulting in a new current ratio of .833.
Peters Company has a 2-to-1 current ratio. This ratio would increase to more than 2 to 1 if
Answer (C) is correct. The current ratio equals current assets divided by current liabilities. Thus, an increase in current assets or a decrease in current liabilities, by itself, increases the current ratio. The sale of inventory at a profit increases current assets without changing liabilities. Inventory decreases, and receivables increase by a greater amount. Thus, total current assets and the current ratio increase.
Merit, Inc., uses the direct write-off method to account for uncollectible accounts receivable. If the company subsequently collects an account receivable that was written off in a prior accounting period, the effect of the collection of the account receivable on Merit’s current ratio and total working capital would be
Answer (B) is correct. Because the company uses the direct write-off method, the original entry involved a debit to a bad debt expense account (closed to retained earnings). The subsequent collection required a debit to cash and a credit to bad debt expense or retained earnings. Thus, only one current asset account was involved in the collection entry, and current assets (cash) increased as a result. If current assets increase and no change occurs in current liabilities, the current ratio and working capital both increase.
The following transactions occurred during a company’s first year of operations:
I. Purchased a delivery van for cash
II. Borrowed money by issuance of short-term debt
III. Purchased treasury stock
Which of the items above caused a change in the amount of working capital?
Answer (D) is correct. Working capital is computed by deducting total current liabilities from total current assets. The purchase of a delivery van for cash reduces current assets and has no effect on current liabilities. The borrowing of cash by incurring short-term debt increases current assets by the same amount as it increases current liabilities; hence, it will have no effect on working capital. The purchase of treasury stock decreases current assets but has no effect on current liabilities. Thus, the purchases of the van and treasury stock affect working capital.
Birch Products, Inc., has the following current assets:
Marketable securities 100,000
Accounts receivable 800,000
If Birch’s current liabilities are $1,300,000 the firm’s
Answer (C) is correct. The only difference between the current ratio and the quick ratio is the removal of inventories from the numerator of the quick ratio. Thus, a shift from cash to inventory will have a reducing effect on the quick ratio that it does not have on the current ratio.
Davis Retail, Inc., has total assets of $7,500,000 and a current ratio of 2.3 times before purchasing $750,000 of merchandise on credit for resale. After this purchase, the current ratio will
Answer (C) is correct. The current ratio is the ratio of current assets to current liabilities. When the ratio is greater than one, any change of equal dollar amount on both the numerator and denominator will result in a lowering of the overall ratio (since the denominator will increase by a proportionally greater amount). The purchase of merchandise on credit is an example of such a change: Inventory increases in the numerator and
accounts payable increases in the denominator by an equal dollar amount.
Markowitz Company increased its allowance for uncollectible accounts. This adjustment will
Answer (D) is correct. The current ratio is the ratio of current assets to current liabilities. By reducing net receivables, an increase in the allowance for uncollectible accounts lowers the amount of current assets (the numerator), reducing the overall ratio.
Garstka Auto Parts must increase its acid test ratio above the current 0.9 level in order to comply with the terms of a loan agreement. Which one of the following actions is most likely to produce the desired results?
Answer (B) is correct. The acid test (quick) ratio consists of the quick assets (cash, marketable securities, and net accounts receivable) divided by current liabilities. Exchanging merchandise inventory for accounts receivable increases the numerator while having no effect on the denominator, resulting in an increase in the overall ratio.
The owner of a chain of grocery stores has bought a large supply of mangoes and paid for the fruit with cash. This purchase will adversely impact which one of the following?
Answer (C) is correct. The quick (acid test) ratio consists of the quick assets (cash, marketable securities, and net accounts receivable) divided by current liabilities. Buying merchandise inventory with cash reduces the numerator, lowering the overall ratio.
Both the current ratio and the quick ratio for Spartan Corporation have been slowly decreasing. For the past two years, the current ratio has been 2.3-to-1 and 2.0-to-1. During the same time period, the quick ratio has decreased from 1.2-to-1 to 1.0-to-1. The disparity between the current and quick ratios can be explained by which one of the following?
Answer (D) is correct. The only difference between the current ratio and the quick ratio is the removal of inventories from the numerator of the quick ratio. Thus, a high inventory balance can account for the disparity between the current and quick ratios.