Best Baskets Limited (BBL) had a current ratio of 0.8:1 before borrowing $50,000 from the bank with a short-term note payable.What effect did the borrowing transaction have on BBL's current ratio?
A)The ratio remained unchanged.
B)The ratio decreased.
C)The ratio increased.
D)Cannot be determined.

Question

Quizplus · Accepted Answer

Borrowing $50,000 with a short-term note payable increases both the current assets (cash) and current liabilities (note payable) by $50,000. Since the current ratio is calculated as current assets divided by current liabilities, and given that BBL's initial current ratio was less than 1 (0.8:1), adding the same amount to both the numerator and the denominator increases the ratio. This is because when the ratio is below 1, increasing both current assets and current liabilities by the same amount makes the gap between them relatively smaller, thus improving the ratio.

Best Baskets Limited (BBL) Had a Current Ratio of 0