As of December 31,Year 1,Gant Corporation had a current ratio of 1.29,quick ratio of 1.05,and working capital of $18,000.The company uses a perpetual inventory system and sells merchandise for more than it cost.On January 1,Year 2,Gant purchased merchandise on account for $4,000.Which of the following statements is true?
A)Gant's current ratio will decrease.
B)Gant's quick ratio will increase.
C)Gant's working capital will increase.
D)Gant's quick ratio will increase and its current ratio will decrease.

Question

Quizplus · Accepted Answer

The purchase of inventory on account is an asset use transaction;the current asset account Inventory increases and the current liability account Accounts Payable also increases.
The current ratio is calculated by dividing current assets by current liabilities.This transaction impacts both the numerator and denominator.To determine the impact,assume that the current ratio of 1.29 suggests that current assets are $129,000 and current liabilities are $100,000 (that is $129,000 ÷ $100,000 = 1.29);the current ratio would decrease as a result of this transaction as follows:
Current ratio = Current assets ÷ Current liabilities
Current ratio = ($129,000 + $4,000)÷ ($100,000 + $4,000)= $133,000 ÷ $104,000 = 1.28.The new current ratio of 1.28 is lower than the old current ratio of 1.29.
The quick ratio is calculated by dividing quick assets (which include the asset accounts Cash,Accounts Receivable,and Current Marketable Securities)by current liabilities.Since this transaction does not affect the numerator but increases the denominator,it decreases the quick ratio.

As of December 31,Year 1,Gant Corporation Had a Current Ratio