Question

Exercise 14-12 Selected Financial Measures for Assessing Liquidity [LO14-2]

Norsk Optronics, ALS, of Bergen, Norway, had a current ratio of 2.5 on June 30 of the current year. On that date, the company’s assets were:

Cash	$	90,000
Accounts receivable, net		260,000
Inventory		490,000
Prepaid expenses		10,000
Plant and equipment, net		800,000
Total assets	$	1,650,000

Required:

1. What was the company’s working capital on June 30?

2. What was the company’s acid-test ratio on June 30? (Round your answer to 2 decimal places.)

3. The company paid an account payable of $40,000 immediately after June 30.

a. What effect did this transaction have on working capital?

b. What effect did this transaction have on the current ratio?

Answer 1

1.
Working capital = Current assets - Current liabilities
= $ 850,000 - $ 340,000
= $ 510,000
Thus, Working capital on june 30 was $ 510,000
Working note:
Current assets:
Cash	$          90,000
Accounts receivable, net	$      2,60,000
Inventory	$      4,90,000
Prepaid expenses	$          10,000
Total current assets	$      8,50,000
Current liabilities:
Current ratio is given 2.5 on june 30.
Current ratio = Current asstes / Current liabilities
Thu,s Current liabilities = Current assets / Current ratio
= $ 850,000 / 2.5
= $ 340,000
2.
Acid-test ratio = (Current assets - Inventories) / Current liabilities
= ( $ 850,000 - $ 490,000 ) / $ 340,000
= $ 360,000 / $ 340,000
= 1.06
Thus, Acid-test ratio on june 30 was 1.06
3.
The company paid an account payable of $40,000 immediately after June 30. Jounral entry as follows:
Debit the accounts payable $ 40,000 and credit the cash account $ 40,000. As accounts payable paid.
Thus, Current assets = $ 850,000 - $ 40,000 = $ 810,000
Current liabilties = $ 340,000 - $ 40,000 = $ 300,000
a.
Working capital = Current assets - Current liabilities
= $ 810,000 - $ 300,000
= $ 510,000
There will not be any effect on working capital as both current assets and current liabilties decreases by same amount.
b.
Current ratio = Current asstes / Current liabilities
= $ 810,000 / $ 300,000
= 2.7
As we can see, Current ratio increases. Current ratio on june 30 was 2.5 and after making payment for accounts payable is 2.7