CH#06: Liquidity of Short-Term Assets; Related Debt-Paying Ability

P 6-20
Depoole Company manufactures industrial products and employs a calendar year
for financial reporting purposes. Items (a) through (e) present several of
Depooles transactions during 2009. The total of cash equivalents, marketable
securities. And net receivables exceeded total current liabilities both before and
after each transaction described. Depoole has positive profits in 2009 a credit
balance throughout 2009 in its retained earning account.
Required: Answer the following multiple-choice questions:
1. Payment of a trade account payable of $ 64,500 would
a.
b.
c.
d.
e.

Increase the current ratio, but the acid-test ratio would not be affected.
Increase the acid-test ratio, but the current ratio would not be affected.
Increase both the current and acid-test ratios.
Decrease both the current and acid-test ratios.
Have no effect on the current and acid-test ratios.

2. The purchase of raw materials for $ 85,000 on open account would

a.
b.
c.
d.
e.

Increase the current ratio.

Decrease the current ratio.
Increase net working capital.
Decrease net working capital.
Increase both the current ratio and net working capital.

3. The collection of current accounts receivable of $29,000 would

a.
b.
c.
d.
e.

Increase the current ratio.

Decrease the current ratio.
Increase the acid-test ratio.
Decrease the acid-test ratio.
No effect the current and acid-test ratios.

4. Obsolete inventory of $125,000 was written-off during 2009.This would

a.
b.
c.
d.
e.

Decrease the acid-test ratio.

Increase the acid-test ratio.
Increase net working capital.
Decrease the current ratio.
Decrease both the current and acid-test ratios.

5. The early liquidation of long-term note with cash would

a.
b.
c.
d.

Affect the current ratio to a greater degree than the acid-test ratio.
Affect the acid-test ratio to a greater degree than the current ratio.
Affect the current and acid-test ratios to the same degree.
Affect the current ratio, but not the acid-test ratio.

e. Affect the acid-test ratio, but not the current ratio.

(CMA Adapted)
P 6-21
Information from Greg Companys balance sheet follows:
Current Assets:
Cash

$ 2,100,000

Marketable securities

7,200,000

Accounts receivable

50,500,000

Inventories

65,000,000

Prepaid expenses
Total current assets

1,000,000
125,800,000

Current liabilities:
Notes payable

$ 1,400,000

Accounts payable

18,000,000

Accrued expense

11,000,000

Income tax payable

Payments due within year on long-term debt
Total current liabilities

600,000
3,000,000
34,000,000

Required: answer the following multiple-choice questions.

1. What is the acid-test ratio of Greg Company?
a.
b.
c.
d.

1.60
1.76
1.90
2.20

2. What is the effect of the collection of accounts receivable on the current ratio
and net working capital, respectively?
Current ratio Net working capital

a. No effect
b. Increase.
c. Increase
d. No effect

No effect
Increase
No effect
Increase

P 6-22
The following data apply to items (a) and (b). Mr. Sparks, the owner of school
supplies, Inc., wants to maintain control over accounts receivable. He
understands that accounts receivable turnover will give a good indication of how
well receivables are being managed. School Supplies Inc., does 70% of its
business during June, July, and August. The term of sale are 2/10, net/60.
Net sales for the year ended December 31, 2009, and receivables balances follow:
Net sales

$1,500,000

Receivables, less allowance for doubtful

Accounts of $ 8000 at January 1, 2009.

72,000

Receivables, less allowance for doubtful

Accounts of $ 10,000 at December 31, 2009.

60,000

Required: Answer the following multiple-choice questions:

1. The average accounts receivable turnover calculated from the previous data is
a.
b.
c.
d.
e.

20.0 times
25.0 times
22. 7 times
18.75 time
20.8 times

2. The average accounts receivable turnover for School Supplies, Inc., in item (a)
is
a. Representative for the entire year
b. Overstated
c. Understated
(CMA Adapted)

P 6-23
Items (a) through (d) are based on the following information:
SHARKEY CORPORATION
Selected Financial Data

As of December 31,
2009

2008

Cash

$8000

$60,000

Marketable securities

32,000

8,000

Accounts receivable

40,000

110,000

Inventory

80,000

140,000

Net property, plant, and equipment

240,000

280,000

Accounts payable

60,000

100,000

Short-term notes payable

30,000

50,000

Cash sales

1,500,000

1,400,000

Credit sales

600,000

900,000

1,260,000

1,403,000

Cost of goods sold

Required: Answer the following multiple-choice questions:

1. Sharkeys acid-test ratio as of December 31, 2009, is
a.
b.
c.
d.

0.63
0.70
0.89
0.99

2. Sharkeys receivable turnover for 2009 is

a.
b.
c.
d.

8 times
6 times
12 times
14 times

3. Sharkeys inventory turnover for 2009 is

a.
b.
c.
d.

11.45 times
10.50 times
9.85 times
8.45 times

4. Sharkeys current ratio at December 31, 2009, is

a. 1.40
b. 2.60
c. 1.90

d. 1.78
5. If current assets exceed current liabilities, payment to creditors made on the
last day of the year will
a.
b.
c.
d.

Decrease current ratio

Increase current ratio
Decrease working capital
Increase working capital

P 6-24 required: Answer the following multiple-choice questions.

1. A Companys current ratio is 2.2 to 1 and quick (acid-test) ratio is 1.0 to 1 at the
beginning of the year. At the end of the year, the company has a current ratio of
2.5 to 1 and a quick ratio of 0.8 to 1. Which of the following could help explain the
divergence in the ratios from the beginning to the end of the year?
a.
b.
c.
d.
e.

An increase in inventory levels during the current year.

An increase in credit sales in relationship to cash sales.
An increase in the use of trade payables during the current year.
An increase in the collection rate of accounts receivable.
The sale of marketable securities at a price below cost.

2. If, just prior to a period of rising prices, a company changed its inventory
measurement method from FIFO to LIFO, the effect in the next period would be to
a.
b.
c.
d.
e.

Increase both the current ratio and inventory turnover.

Decrease both the current ratio and inventory turnover.
Increase the current ratio and decrease inventory turnover.
Decrease the current ratio and increase inventory turnover.
Leave the current ratio and inventory turnover unchanged.

3. Selected year-end data for Bayer Company are as follows:

Current liabilities

$ 600,000

Acid-test ratio

2.5

Current ratio

3.0

Cost of sales

$ 500,000

Bayer Companys inventory turnover based on these year-end data is

a.
b.
c.
d.
e.

1.20
2.40
1.67
Some amount other than those given.
Not determinable from the data given.

4. If a firm has a higher current ratio but a low acid-test ratio, one can conclude
that
a.
b.
c.
d.
e.

This firm has a large outstanding accounts receivable balance.

This firm has a large investment in inventory.
The firm has a large amount of current liabilities.
The cash ratio is extremely high.
The two ratios must be recalculated because both conditions cannot occur
simultaneously.

5. Investment instruments used to invest temporarily idle cash balances should

have which of the following characteristics?
a.
b.
c.
d.
e.

High expected return, low marketability, and a short term to maturity.

High expected return, readily marketable, and no maturity date.
Low default risk, low marketability, and a short term to maturity.
Low default risk, readily marketable, and a long term to maturity.
Low default risk, readily marketable, and a short term to maturity.

6. The primary objective in the management of accounts receivable is

a. To achieve a combination of sales volume, bad-debt experience, and receivables
turnover that maximizes the profits of the corporation.
b. To realize no bad debts because of the opportunity cost involved.
c. To provide treasurer of the corporation with sufficient cash to pay the companys
bills on time.
d. To coordinate the activities of manufacturing, marketing, and financing so that the
corporation can maximize its profits.
e. To allow the most liberal credit acceptance policy because increased sales mean
increased profits,
7. A firm requires short-term funds to cover payroll expenses. These funds can
come from
a.
b.
c.
d.

Trade credit
Collection of receivables.
Bank loans
Delayed payments of accounts payable.
e. All of the above.

(CMA Adapted)