Question 1

A low sales to working capital ratio tentatively indicates an unprofitable use of working capital.

Accepted Answer

A low sales to working capital ratio indicates that a company's revenue is low relative to the amount of working capital invested. This suggests that the company may not be utilizing its working capital efficiently or effectively, which could lead to lower profits.

Question 2

Liquidity problems with receivables and/or inventory means that the current ratio needs to be much higher than when there are no such liquidity problems.

Accepted Answer

Liquidity problems with receivables and/or inventory indicate that a company may have difficulty in generating cash flow in the short-term. This would require a higher current ratio (current assets divided by current liabilities) to ensure that the company can meet its short-term obligations. A higher current ratio indicates that the company has more current assets to cover its current liabilities, making it more likely to be able to pay its bills and debts on time. Therefore, if a company has liquidity problems with receivables and/or inventory, a higher current ratio would be necessary to reflect this.

Question 3

Working capital of a business is the excess of current assets over current liabilities.

Accepted Answer

Working capital is calculated as the difference between current assets and current liabilities, which represents the amount of funds available for a business to finance its day-to-day operations. Therefore, the statement "Working capital of a business is the excess of current assets over current liabilities" is true.

Question 4

Current assets are assets that (1)are in the form of cash, (2)will be realized in cash,or (3)conserve the use of cash within the operating cycle of a business or for one year,whichever is shorter.

Accepted Answer

The answer of Current assets are assets that (1)are in...

Question 5

Customer concentration can be an important consideration in the quality of receivables.

Accepted Answer

Customer concentration refers to the degree to which a company's sales are made to a few key customers. If a significant portion of a company's sales come from a small number of customers, this can increase the credit risk associated with those sales. If the company loses one or more of these customers or if they experience financial difficulties, it can have a significant impact on the company's ability to collect its receivables. Therefore, customer concentration is an important consideration in the quality of receivables.

Question 6

The LIFO inventory costing method usually results in working capital being overstated.

Accepted Answer

The LIFO (Last In, First Out) inventory costing method typically results in lower reported inventory values during periods of inflation, which can lead to a lower working capital figure, not an overstated one.

Question 7

In order to classify cash as a current asset,it must be free from any restrictions that would prevent its deposit or use to pay creditors classified as long-term.

Accepted Answer

Cash can still be classified as a current asset even if there are restrictions on its use, as long as it is expected to be used or available to meet current obligations. Restrictions do not necessarily preclude it from being a current asset.

Question 8

Alpha Company would like to estimate how long it will take to realize cash from its ending inventory.For this purpose the following data are submitted:
 $\begin{array}{c}
\begin{array}{lll}
 \text {Accounts Receivable, less allowance for doubtful accounts of $ \$ 40,000 $ }\
 \text {Ending Inventory}\
 \text {Net Sales}\
\text { Cost of Goode Sold }
\end{array}
\begin{array}{lll}
\$660,000\
750,00\
5,650,000\
4,250,000
\end{array}
\end{array}$
 
 $\text { Days' Sales in Inventory } = \frac { \text { Ending Inventory } } { \text { Cost of Goods Sold } / 365 }$ 
 $\text { Days' Sales in Receivables } = \frac { \text { Gross Receivables } } { \text { Net Sales } / 365 }$ 
Required:
Estimate how long it will take to realize cash from the ending inventory.

Accepted Answer

The answer of Alpha Company would like to estimate how...

Question 9

Management should usually strive to keep the cash ratio high.

Accepted Answer

The cash ratio is a liquidity measure that shows a company's ability to cover its short-term obligations with its cash and cash equivalents. While having some liquidity is important, a very high cash ratio might indicate that the company is not efficiently using its cash resources to invest in growth opportunities or other assets that could generate higher returns.

Question 10

A shortening of the credit terms is an indication that there will be more risk in the collection of future receivables.

Accepted Answer

A shortening of the credit terms typically indicates a reduction in the time customers are allowed to pay their invoices, which can actually lead to a decrease in the risk of collection issues, as customers are required to pay more quickly.

Question 11

If the company closes the year when the activities are at a peak,the number of days' sales in inventory would tend to be overstated and the liquidity would be overstated.

Accepted Answer

Closing the year when activities are at a peak typically results in a lower number of days' sales in inventory because the cost of goods sold is higher, which makes the inventory turnover appear faster. Liquidity might not necessarily be overstated as it depends on other factors like current assets and liabilities, not just inventory levels.

Question 12

The company with the natural business year tends to overstate its accounts receivable turnover,thus overstating its liquidity.

Accepted Answer

When a company has a natural business year, it means that its accounting period ends at a time that coincides with the end of a business cycle, such as the end of a season. This can lead to fluctuations in its accounts receivable turnover, making it easier for the company to manipulate or overstate this metric. Overstating accounts receivable turnover can give the impression that the company is more liquid than it actually is, which can be misleading to investors and creditors.

Question 13

An approximation of the operating cycle can be determined from the receivable liquidity figures and the inventory liquidity figures.

Accepted Answer

The receivable liquidity figures and inventory liquidity figures are key components in determining the operating cycle. The operating cycle refers to the time it takes for a company to convert its inventory into cash. By analyzing these two liquidity figures, an estimate of the operating cycle can be calculated.

Question 14

The operating cycle is the time between the acquisition of inventory and the realization of cash from selling the inventory.

Accepted Answer

The definition of the operating cycle includes both the acquisition of inventory and the realization of cash from selling that inventory, therefore the statement is true.

Question 15

The use of the allowance for doubtful accounts results in the bad debt expense being charged to the period of sale.

Accepted Answer

The allowance for doubtful accounts is a contra asset account that is used to estimate and account for the portion of accounts receivable that may not be collected. By using this allowance, the bad debt expense can be recognized and charged to the period in which the related sales were made. This is done in accordance with the matching principle of accounting, which requires that expenses be recognized in the same period as the related revenues. Thus, the use of the allowance for doubtful accounts is an important tool for accurately reporting bad debt expenses and ensuring that they are properly matched with the period of sale.

Question 16

Even an entity on a very profitable course will find itself bankrupt if it fails to meets its obligations to short-term creditors.

Accepted Answer

Short-term creditors provide necessary funding to cover immediate expenses such as payroll, rent, and inventory. If an entity is unable to meet its obligations to these creditors, it can quickly find itself in financial distress, even if it appears to be profitable in the long-term.

Question 17

The ability of an entity to maintain its short-term,debt-paying ability is important to all users of financial statements.

Accepted Answer

The ability of an entity to maintain its short-term, debt-paying ability is a key aspect of its financial health, and is important to all users of financial statements, including investors, lenders, and analysts. This information can be found in the entity's balance sheet and cash flow statement, which provide insights into its liquidity, working capital position, and ability to meet its financial obligations in the near term.

Question 18

Working capital is considered to be more indicative of the short-term,debt-paying ability than is the current ratio.

Accepted Answer

The current ratio is actually a more direct measure of a company's ability to pay its short-term debts, as it compares current assets to current liabilities, directly reflecting short-term liquidity. Working capital, which is the difference between current assets and current liabilities, provides a dollar figure but does not offer the proportional comparison that the current ratio does.

Question 19

The cash ratio is usually a good indication of the liquidity of the firm.

Accepted Answer

The answer of The cash ratio is usually a good...

Question 20

The LIFO inventory costing method results in the acid-test ratio being overstated.

Accepted Answer

The LIFO inventory costing method results in the acid-test ratio being understated, not overstated. This is because LIFO assumes that the most recent inventory items purchased are the first to be sold, which means that the value of the inventory on the balance sheet is likely to be understated compared to the market value. As a result, the acid-test ratio, which is a measure of a company's short-term liquidity, is also understated because it excludes inventory from the calculation.

Quiz 6: Liquidity of Short-Term Assets;related Debt-Paying Ability