Ed's Drive-In had $175,000 of current assets and $80,000 of current liabilities before borrowing $60,000 from the bank with a 3-month note payable. What effect did the borrowing transaction have on Ed's Drive-In's current ratio?
A) The ratio remained unchanged.
B) The change in the current ratio cannot be determined.
C) The ratio decreased.
D) The ratio increased.

Question

Quizplus · Accepted Answer

Before borrowing, Ed's Drive-In's current ratio was:

Current Ratio = Current Assets / Current Liabilities 
Current Ratio = $175,000 / $80,000 
Current Ratio = 2.1875

After borrowing, the current liabilities increase by $60,000 (the note payable).

New Current Liabilities = $80,000 + $60,000 = $140,000

So the new current ratio is:

Current Ratio = Current Assets / New Current Liabilities 
Current Ratio = $175,000 / $140,000 
Current Ratio = 1.25

Therefore, the borrowing transaction decreased Ed's Drive-In's current ratio from 2.1875 to 1.25.

Ed's Drive-In Had $175,000 of Current Assets and $80,000 of Current