Sheena Company has current assets, current liabilities, and long-term liabilities of $20,000, $13,000, and $17,000, respectively. Within these amounts, $2,000 is accounts payable, and $3,500 is accounts receivable. If $2,000 of cash were used to pay off the accounts payable, what effect would this have on the current ratio?
A)The current ratio would increase by approximately 0.10.
B)The current ratio would decrease by approximately 0.10.
C)The current ratio would decrease by approximately 0.03.
D)There would be no change in the current ratio.

Question

Quizplus · Accepted Answer

The current ratio is calculated by dividing current assets by current liabilities.

Before the payment of the accounts payable, the current assets are $20,000 and the current liabilities are $13,000. So, the current ratio is:

Current ratio = Current assets / Current liabilities
Current ratio = $20,000 / $13,000
Current ratio = 1.54

If $2,000 of cash is used to pay off the accounts payable, the current assets will decrease to $18,000 and the current liabilities will also decrease to $11,000.

Therefore, the new current ratio will be:

New current ratio = Current assets / Current liabilities
New current ratio = $18,000 / $11,000
New current ratio = 1.64

The difference between the old current ratio and new current ratio is:

Change in current ratio = New current ratio - Current ratio
Change in current ratio = 1.64 - 1.54
Change in current ratio = 0.10

So, the current ratio would increase by approximately 0.10. Therefore, the correct answer is A.

Sheena Company Has Current Assets, Current Liabilities, and Long-Term Liabilities