Question

Distinguish between fixed and current assets and describe current ratio.

Answer 1

Fixed assets VS Current assets

When a business entity acquires an asset with an intention of using it in business or perform business operations with that asset it will be called as fixed asset. Generally the life of such assets or economic benefit expected from such assets is likely to spread over some number of years into future. In accounting terminology they are capital expenditures involving huge cash outlay in the inspection and followed by a stream of cash in flows. Annual decrease in the value of fixed assets due to wear and tear is accounting as annual depreciation. Thus depreciation is a unique feature of fixed assets with limited life. Examples include ..... Plant and machinery, furniture, Factory buildings etc

On the other hand, current assets are those assets aquired or resulted in business operations whose purpose is to hold them with an intention of converting them with in an accounting year. Examples include, Inventory of raw material, work in process, finished goods, receivables and cash balance as well.

Thus the main difference lies in the intention of the business. Land and building is generally regarded as a fixed asset for manufacturing organisations. But the same land and building for real estate business entities can be a current assets when the principle activity of such real estate is to sell such land and buildings in due course of business.

Current ratio

Current ratio establishes a relationship between current assets and current liabilities. The purpose of this ratio is to test the ability of the firm to pay the current obligations as and when they araise.

Current ratio = Current assets / Current liabilities.

This ratio is also know as working capital ratio. A ratio in excess of 1:1 indicates that firm will be able ot pay the short term liabilities. But financial experts advocates a ratio of 2:1 as ideal, such that some part of the working capital needs were financed from long term source of finance. Such a ratio provides safety in terms of saving the goodwill of the organisation in the event of delay in collection of current assets.