ABC Company has a Current Ratio of 2.0. Explain what will happen to the value of
ID: 2808863 • Letter: A
Question
ABC Company has a Current Ratio of 2.0. Explain what will happen to the value of the Current Ratio in each of the following cases: a) The company sells existing inventory at a profit and is paid in cash. b) The company sells existing inventory at a profit as a credit sale. c) The company uses cash to pay off notes payable to the bank. d) The company sells bonds and uses the money to buy fixed assets. e) The company collects existing accounts receivable for cash. f The company writes off obsolete inventoryExplanation / Answer
a)since the inventory is sold at a profit current ratio will increase .This is so becasue sale of inventory will decrease current asset but cash received will increase the current asset by higher amount (than cost of inventory since sold at profit )as a result overall current ratio will increase.
b)since the inventory is sold at a profit current ratio will increase .This is so becasue sale of inventory will decrease current asset but Accounts receivable will increase the current asset by higher amount (than cost of inventory since sold at profit )as a result overall current ratio will increase.
c)current ratio will increase .say existing current asset is 1000 and current liability is 500
if note payable is paid by way of cash $ 100 ,new current asset= 1000-100=900 ,current liability = 500-100=400
new current ratio = 900/400 = 2.25
d)no effect since bond is not a part of current liability (unaffected ).also cash received is used to buy fixed asset which is not a part of current asset (unaffected)
e)No effect since decrease in current asset (accounts receivable)is offset by increase in current asset(Cash) by same amount
f)Decrease ,since inventory is decreased.