Question

Question: Wild Adventure conducts tours of wildlife reserves around the world. The company recently purchased a lodge in Adelaide, Australia, securing a 4% mortgage from First Bank. In addition to monthly payments, Wild Adventure must provide annual reports to the bank showing that the company has a current ratio of 1.2 or better. After reviewing the annual reports, the CEO, N. O. Scrooge, approached Carl Hauptfleisch, the CFO, and stated, “We’ve decided we are going to move all our long-term debt investments into our brokerage account so we can sell them soon. Carl, go ahead and make the adjusting entries as of the current year-end.” Carl made the adjustments even though he doesn’t think the company will actually go ahead with the planned sale of the long-term debt investments. The subsequent year, the economy turned, and the company’s travel revenues dropped more than 60%. Wild Adventure eventually defaulted on the First Bank loan.

Requirements

1. What effect did the adjustments have on the financial statements? What effect did the adjustments have on the current ratio?

Short answer

Answer

Current assets will increase with an amount equal to a decrease in long-term assets, and the current ratio will also increase

Step-by-step solution

Definition of Current Ratio

A financial metric that reflects the business entity’s performance by assessing its ability to repay short-term loans is the current ratio. The assessment is made using the current assets and current liabilities.

Effect on Financial Statements and Current Ratio

Due to the transfer of long-term assets of the business entity to current assets, total assets will remain unaffected. Still, the sub-total of long-term assets will decline, and the sub-total of the current asset will increase.

Due to the increase in the current assets, the company's current ratio will increase.