Question

Howell Company has the following selected accounts after posting adjusting entries:

Accounts Payable                                                                  €75,000

Notes Payable, 3-month                                                           80,000

Accumulated Depreciation—Equipment                                14,000

Salaries and Wages Payable                                                    27,000

Notes Payable, 5-year, 8%                                                       30,000

Warranty Liability                                                                   34,000

Salaries and Wages Expense                                                     6,000

Interest Payable                                                                         3,000

Mortgage Payable                                                                  200,000

Sales Taxes Payable                                                                21,000

Instructions

(a)    Prepare the current liability section of Howell Company's statement of financial position, assuming €25,000 of the mortgage is payable next year. (List liabilities in magnitude order, with largest first.)

(b)    Comment on Howel's liquidity, assuming total current assets are €500,000.

Answer 1

(a) Current Liabilities :

Current Liabilities
Notes Payable, 3 Month	80000
Account Payable	75000
Salaries and Wages payable	27000
Mortgage Payable	25000
Sales Tax Payable	21000
Interest Payable	3000
Total	231000

Notes:

1. Accumulated Depreciation is not a liability. It is a charge on asset. So, not considered in cuurent liability section.

2.Notes Payable 5 Years 8% is a Long term Liability. So, not taken in current liability section.

3. It is not mentioned in the question that warrant liability is certain to be paid in next year. So, it is assumed that the same is not expected to realise within next 12 month period as on balance sheet date. So, not taken in current liability section.

4. Salaries and Wages payable is item of current liabilites. Salaries and wages expenses is an item which is taken in profit and loss account as expense of the period. So, the same is not included in current liability section.

5. It is mentioned that 25000 of mortgage payable is required to be paid in next financial year. So, 25000 of Mortage payable is taken as current liability and the remaining amount will be included in Long Term Liability.

(b)

Current Ratio of Howel's = Current Assets / Current Liabilities

= 500000 / 231000

= 2.16 Times (Approx.)

Current Ratio is a liquidity ratio that measures a company's ability to pay its short term obligations or those due within one year. The higher the current ratio, the more capable a company is of paying its obligations because it has a larger proportion of short-term asset value relative to the value of its short-term liabilities. However, while a high ratio, say over 3, could indicate the company can cover its current liabilities three times, it may indicate that it's not using its current assets efficiently, is not securing financing very well, or is not managing its working capital.

In the given case, Howels' has current ratio of 2.16 means it have suffient current assets to pay its short term obligations within a year. So, Howel's liquidity postion can be considered good.

On the other hand, its current ratio is not as high as 3 times, so it can also be said that Howel's is efficiently utilising its current assets.

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