At December 30, 20X3, Vida Co. had cash of $200,000, a current ratio of 1.5:1 and a quick ratio of .5:1. On December 31, 20X3, all cash was used to reduce accounts payable. How did these cash payments affect the ratios?

Question

Quizplus · Accepted Answer

Choice "a" is correct. The current ratio equals current assets divided by current liabilities. Since the current assets exceed the current liabilities (as evidenced by a current ratio of 1.5:1), when each is decreased by the same amount, there will be a greater percentage reduction of the current liabilities. Thus, the ratio will increase since the current assets are now proportionately larger than the current liabilities. The quick ratio equals quick assets (including cash) divided by current liabilities. Since the quick assets are less than the current liabilities (as evidenced by a quick ratio of .5:1), when each is decreased by the same amount, the percentage decrease of the quick assets will be greater than that of the current liabilities. Thus, the ratio will decrease since the quick assets are now proportionately smaller than the current liabilities. Choices "B", "C", and "D" are incorrect, per the above Explanation.