Question

Assume that the current ratio for Arch Company is 3.0, its acid-test ratio is 1.5, and its working capital is $310,000. Answer each of the following questions independently, always referring to the original information.

Required:

a. How much does the firm have in current liabilities?

b. If the only current assets shown on the balance sheet for Arch Company are Cash, Accounts Receivable, and Merchandise Inventory, how much does the firm have in Merchandise Inventory?

c. If the firm collects an account receivable of $107,000, what will its new current ratio and working capital be?

d. If the firm pays an account payable of $58,000, what will its new current ratio and working capital be?

e. If the firm sells inventory that was purchased for $50,000 at a cash price of $63,000, what will its new acid-test ratio be?

Answer 1

Answer a)

Calculation of Current Liabilities

Current Ratio = Current assets/ Current liabilities

                      3 = Current assets/ Current liabilities

Current Assets = 3 X Current Liabilities              ………………..Equation -1

Working capital = Current assets – Current liabilities

Substituting the value of current assets from Equation -1 on the above formula we get

Working Capital = 3 X Current Liabilities – Current Liabilities

$ 310,000 = 2 X Current Liabilities

Current liabilities = $ 155,000

Therefore the value of Current Liabilities is $ 155,000

Answer b)

Calculation of merchandise inventory

Acid-test Ratio = Quick assets/ Current liabilities

1.50 = Quick Assets/ $ 155,000

Quick Assets = $ 155,000 X 1.50

Quick Assets = $ 232,500

Current Assets = 3 X Current Liabilities   (Equation -1)

Current Assets = 3 X $ 155,000

Current Assets =$ 465,000

As given in the Question,

Current Assets = Cash + Account receivable + Inventory

Out of these current assets, Quick assets comprise of Cash and Account receivable. Thus the value of cash and accounts receivable is $ 232,500. Substituting this value in the above equation we get.

Current Assets = Cash + Account receivable + Inventory

$ 465,000 = $ 232,500 + Inventory

Inventory = $ 465,000 - $ 232,500

Inventory = $ 232,500

Therefore the value of merchandise inventory is $ 232,500

Answer c)

If the firm collects an amount of $ 107,000 from accounts receivable:

· Its accounts receivable will reduce by $ 107,000.

· Its cash balance will increase by $ 107,000.

Thus the amount of Current assets and current liabilities will remain same.

Since there is no change in the aggregate amount of current assets and current liabilities, its current ratio will remain at 3.00 times and working capital will remain at $ 310,000.

Answer d)

If the firm pays an amount of $ 58,000 against account payable:

· Its Current liabilities will reduce by $ 58,000 (as account payable is reduced)

· Its Current assets will reduce by $ 58,000 (as cash balance is reduced)

The new balance will be as follows:

Current assets = $ 465,000 - $ 58,000

                           = $ 407,000

Current liabilities = $ 155,000 - $ 58,000

                                = $ 97,000

Revised figures:

Current ratio = Current assets/ current liabilities

                        = $ 407,000/ $ 97,000

                        = 4.196 times (Approximately)

Working capital = Current assets - current liabilities

                            = $ 407,000 - $ 97,000

                              =$ 310,000

Answer e)

If the sells inventory costing $ 50,000 for cash price of $ 63,000

• Its Current Assets will decrease by $ 50,000 (as inventory balance is reduced)
• Its Current assets will also increase by $ 63,000 (as cash balance is increased)

The new balance will be as follows:

Current assets = $ 465,000 - $ 50,000 + $ 63,000

                           = $ 478,000

Current liabilities = $ 155,000

Calculation of Quick Assets:

As already calculated in the part (b) of the question, the value of Merchandise inventory is $ 232,500. Since inventory costing (book value) $ 50,000 is sold from this inventory, the balance of merchandise inventory will be $ 182,500 (i.e. $ 232,500 - $ 50,000).

Quick Assets = Current Assets – Merchandise inventory

                        = $ 478,000 - $ 182,500

                        = $ 295,500

Thus the value of Quick assets will be $ 295,500

Revised figures:

Acid-test ratio = Quick assets/ current liabilities

                        = $ 295,500/ $ 155,000

                        = 1.906 times (Approximately)