Chapter 8, Problem 8.2APFA

Requirement – 1

To determine

To calculate: The current ratio for the past two year, and discuss whether the current ratio improve or weaken in the most recent year.

Explanation of Solution

Current ratio:

Current ratio is used to determine the relationship between current assets and current liabilities. Current ratio is determined by dividing current assets and current liabilities.

Formula:

$\text{Current Ratio}=\frac{\text{Current assets}}{\text{Current}\text{liabilities}}$

The current ratio of Company A for the past two year is as follows:

In 2015:

Here,

Current assets = $890,513 thousand

Current liabilities = $459,093 thousand

$\begin{array}{c}\text{Current ratio}=\frac{\text{Current assets}}{\text{Current}\text{liabilities}}\\ =\frac{\$890,513\text{thousand}}{\$459,093\text{thousand}}\\ =\text{1}\text{.94 times}\end{array}$

In 2014:

Current assets = $927,991 thousand

Current liabilities = $415,478 thousand

$\begin{array}{c}\text{Current ratio}=\frac{\text{Current assets}}{\text{Current}\text{liabilities}}\\ =\frac{\$927,991\text{thousand}}{\$415,478\text{thousand}}\\ =\text{2}\text{.24 times}\end{array}$

Conclusion

Therefore, the current ratio in the most recent year (2015) is weakened.

Requirement – 2

To determine

To calculate: The acid test ratio for the past two year, and discuss whether the acid test ratio improve or weaken in the most recent year.

Explanation of Solution

Acid-test Ratio:

It is a ratio used to determine a company’s ability to pay back its current liabilities by liquid assets that are current assets except inventory and prepaid expenses.

Formula:

$\text{Acid-test Ratio}=\frac{\text{Cash}+\text{Accounts Receivable}+\text{Short-term Investments}}{\text{Current Liabilities}}$

The acid test ratio of Company A for the past two year is as follows:

In 2015:

Here,

Cash= $410,697 thousand

Accounts receivable = $67,894 thousand

Short-term investment= $0 thousand

Current liabilities = $459,093 thousand

$\begin{array}{c}\text{Acid-test ratio}=\frac{\left(\begin{array}{l}\text{Cash}+\text{Short-term investments}\\ +\text{Accounts receivable}\end{array}\right)}{\text{Current liabilities}}\\ =\frac{\left(\begin{array}{l}\$410,697\text{thousand}+\$0thousand+\\ \$67,894\text{thousand}\end{array}\right)}{\$459,093\text{thousand}}\\ =1.04\text{times}\end{array}$

In 2014:

Here,

Cash= $418,933 thousand

Accounts receivable = $73,882 thousand

Short-term investment= $10,002 thousand

Current liabilities = $415,478 thousand

$\begin{array}{c}\text{Acid-test ratio}=\frac{\left(\begin{array}{l}\text{Cash}+\text{Short-term investments}\\ +\text{Accounts receivable}\end{array}\right)}{\text{Current liabilities}}\\ =\frac{\left(\begin{array}{l}\$418,933\text{thousand}+\$10,002thousand\\ +\$73,882\text{thousand}\end{array}\right)}{\$415,478\text{thousand}}\\ =1.21\text{times}\end{array}$

Conclusion

Therefore, the acid test ratio in the most recent year (2015) is weakened.

Requirement – 3

To determine

The manner in which the current ratio and acid test ratio will change, if Company A used $100 million in cash to pay $100 million in accounts payable.

Explanation of Solution

Calculate current ratio if company used $100 million in current investments to pay $100 million in current accounts payable.

If the company used $100 million in current investments to pay $100 million in current accounts payable, the current assets and the current liabilities both decreases by $100 million. Thus, this transaction increases the current ratio. The calculation is as given below:

$\begin{array}{c}\text{Current Ratio}=\frac{\text{Current assets}}{\text{Current}\text{liabilities}}\\ =\frac{\$890,513,000-\text{\$100,000,000}}{\$459,093,000-\text{\$100,000,000}}\\ =\text{2}\text{.20 times}\end{array}$

Calculate acid-test ratio if company used $100 million in current investments to pay $100 million in current accounts payable.

If the company used $100 million in current investments to pay $100 million in current accounts payable, the quick assets and the current liabilities both decreases by $100 million. Thus, this transaction increases the acid-test ratio. The calculation is as given below:

$\begin{array}{c}\text{Acid-test ratio}=\frac{\left(\begin{array}{l}\text{Cash}+\text{Short-term investments}\\ +\text{Accounts receivable}\end{array}\right)}{\text{Current liabilities}}\\ =\frac{\left(\begin{array}{l}\$410,697,000+\$0+\$67,894,000\\ -\$100,000,000\end{array}\right)}{\$459,093,000-\$100,000,000}\\ =1.06\text{times}\end{array}$

Conclusion

Therefore, both current and acid test ratio is increased.