Question

Answer each of the questions in the following unrelated situations.

c) A company has current assets of \(90,000 (of which \)40,000 is inventory and prepaid items) and current liabilities of \(40,000. What is the current ratio? What is the acid-test ratio? If the company borrows \)15,000 cash from a bank on a 120-day loan, what will its current ratio be? What will the acid-test ratio be?

Short answer

The current ratio is 2.25:1, the new current ratio is 1.91:1

Acid-test ratio is 1.25:1, the new acid-test ratio is 1.81:1

Step-by-step solution

Meaning of Current Ratio

The current ratio can be ascertained by dividing the current asset by current liabilities. It is the ratio that helps to meet short-term obligations, such as those that are due within a year.

Determining the different ratios in (c)

Current ratio = 2.25:1

$\begin{array}{rcl}\mathrm{Current}\mathrm{ratio}& =& \frac{\mathrm{Current}\mathrm{assets}}{\mathrm{Current}\mathrm{liabilities}}\\ & =& \frac{\$90,000}{\$40,000}\\ & =& 2.25:1\end{array}$

Acid-test ratio = 1.25:1

$\begin{array}{rcl}\mathrm{Acid}-\mathrm{test}\mathrm{ratio}& =& \frac{\mathrm{Total}\mathrm{amount}\mathrm{of}\mathrm{cash},\mathrm{accounts}\mathrm{receivable}\mathrm{and}\mathrm{short}-\mathrm{term}\mathrm{investments}}{\mathrm{Current}\mathrm{liabilities}}\\ & =& \frac{\$50,000}{\$40,000}\\ & =& 1.25:1\end{array}$

Therefore, the calculation of new ratios are as follows:

New current ratio = 1.91:1

$\begin{array}{rcl}\mathrm{Current}\mathrm{ratio}& =& \frac{\mathrm{Current}\mathrm{assets}}{\mathrm{Current}\mathrm{liabilities}}\\ & =& \frac{\$105,000}{\$55,000}\\ & =& 1.91:1\end{array}$

New Acid test ratio = 1.18:1

$\begin{array}{rcl}\mathrm{Acid}-\mathrm{test}\mathrm{ratio}& =& \frac{\mathrm{Total}\mathrm{amount}\mathrm{of}\mathrm{cash},\mathrm{accounts}\mathrm{receivables}\mathrm{and}\mathrm{short}\mathrm{term}\mathrm{investments}}{\mathrm{Current}\mathrm{liabilities}}\\ & =& \frac{\$65,000}{\$55,000}\\ & =& 1.18:1\end{array}$