Chapter 8, Problem 3AP

1.

To determine

Calculate the current ratio for the past two year, and discuss whether the current ratio has been increased or decreased in the most recent year.

Explanation of Solution

Current ratio:

The financial ratio which evaluates the ability of a company to pay off the debt obligations which mature within one year or within completion of operating cycle is referred to as current ratio. This ratio assesses the liquidity of a company.

Formula:

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

The current ratio of Company B for the past two year is as follows:

For 2018:

$\begin{array}{c}\text{Current ratio}=\frac{\text{Current assets}}{\text{Current}\text{liabilities}}\\ =\frac{\$360,584\text{ thousand}}{\$97,906\text{thousand}}\\ =3.68\text{ times}\end{array}$

For 2017:

$\begin{array}{c}\text{Current ratio}=\frac{\text{Current assets}}{\text{Current}\text{liabilities}}\\ =\frac{\$386,457\text{ thousand}}{\$98,616\text{ thousand}}\\ =3.\text{92 times}\end{array}$

Conclusion

From the above calculation it is clear that the current ratio in the most recent year (2018) has been declined.

2.

To determine

Calculate the acid test ratio for the past two year, and discuss whether the acid test ratio has been increased or decreased in the most recent year.

Explanation of Solution

Acid-test ratio:

The financial ratio which evaluates the ability of a company to pay off the instant debt obligations is referred to as quick ratio. Quick assets are cash, marketable securities, and accounts receivables. This ratio assesses the short-term liquidity of a company.

Formula:

$\text{Acid-test Ratio}=\frac{\text{Cash}+\text{Accounts Receivable}+\text{Short-term Investments}}{\text{Current Liabilities}}$

The acid test ratio of Company B for the past two year is as follows:

For 2018:

$\begin{array}{c}\text{Acid-test ratio}=\frac{\left(\begin{array}{l}\text{Cash}+\text{Short-term investments}\\ +\text{Accounts receivable}\end{array}\right)}{\text{Current liabilities}}\\ =\frac{\left(\begin{array}{l}\$165,086\text{thousand}+\$50,833\\ thousand+\$8,588\text{thousand}\end{array}\right)}{\$97,906\text{thousand}}\\ =2.29\text{times}\end{array}$

In 2017:

$\begin{array}{c}\text{Acid-test ratio}=\frac{\left(\begin{array}{l}\text{Cash}+\text{Short-term investments}\\ +\text{Accounts receivable}\end{array}\right)}{\text{Current liabilities}}\\ =\frac{\left(\begin{array}{l}\$196,536\text{thousand}+\$49,994thousand\\ +\$8,210\text{thousand}\end{array}\right)}{\$98,616\text{thousand}}\\ =2.58\text{times}\end{array}$

Conclusion

From the above calculation it is clear that the acid test ratio in the most recent year (2018) has been declined.

3.

To determine

Explain the manner in which the current ratio and acid test ratio will change, if Company B purchased $50 million of inventory by debiting inventory and crediting accounts payable.

Explanation of Solution

Calculate the current ratio of company B, if company purchased $50 million of inventory by debiting inventory and crediting accounts payable.

If the company purchase $50 million of inventory, both current assets (inventory) and current liabilities (accounts payable) get increased by $50 million. Thus, this transaction decreases the current ratio. The calculation is as given below:

$\begin{array}{c}\text{Current Ratio}=\frac{\text{Current assets}}{\text{Current}\text{liabilities}}\\ =\frac{\$360,584+\$50,000}{\$97,906+\$50,000}\\ =\text{2}\text{.78 times}\end{array}$

Calculate acid-test ratio if company purchased $50 million of inventory by debiting inventory and crediting accounts payable.

If the company purchases $50 million of inventory, the current liabilities increase by $50 million, but the quick assets remain same.  Hence, this transaction decreases the acid-test ratio. The calculation is as given below:

$\begin{array}{c}\text{Acid-test ratio}=\frac{\left(\begin{array}{l}\text{Cash}+\text{Short-term investments}\\ +\text{Accounts receivable}\end{array}\right)}{\text{Current liabilities}}\\ =\frac{\left(\begin{array}{l}\$165,086+\$50,833\\ +\$8,588+\$50,000\end{array}\right)}{\$97,906+\$50,000}\\ =1.86\text{times}\end{array}$

Conclusion

Therefore, both current and acid test ratio is decreased.