Chapter 14, Problem 4DQ

To determine

Current ratio and acid-test ratio

Current ratio: Current ratio is used to determine the relationship between current assets and current liabilities. The ideal current ratio is 2:1.

Formula:

$\text{Current ratio}=\frac{\text{Current assets}}{\text{Current}\text{liabilities}}$

Acid-Test Ratio: This ratio denotes that this ratio is a more rigorous test of solvency than the current ratio. It is determined by dividing quick assets and current liabilities. The acceptable acid-test ratio is 0.90 to 1.00. Use the following formula to determine the acid-test ratio:

$\text{Acid Ratio}=\frac{\text{Quick assets}}{\text{Current}\text{liabilities}}$

Quick Assets are those assets that are most liquid. The examples of quick assets include cash and bank balances, marketable securities, and sundry debtors. Use the following formula to determine the Quick assets:

$\text{Quick Assets}=\text{Current assets}-\left(\text{Stock}+\text{Prepaid Expenses}\right)$

To compare: Current and quick ratios of the service revenue.