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Chapter 13: Question 30Q (page 691)

How does the acid-test ratio differ from the current ratio? How are they similar?

Short Answer

Expert verified

The primary difference between the acid-test ratio and the current ratio is that the current ratio estimates the ability of the company to clear off its debts by using short-term assets. On the other hand, the acid-test ratio or quick ratio evaluates the ability of the company to clear its debts by using short-term assets excluding inventory.

The acid test ratio is similar to the current ratio as both highlight the liquidity of the company.

Step by step solution

01

Definition of Ratio

The ratio can be defined as the measure of one value or number in relation to another. A ratio can be expressed in various ways, including as a percentage, a fraction, a 鈥渢imes鈥� figure, a number of days, a rate, or as a simple manner. Ratios are just signals or clues rather than the answers to complex questions about a company.

02

Difference between acid-test ratio and a current ratio

Acid-test ratio and current ratio can be distinguished on the following grounds:

  • Current ratio is the ratio that evaluates the potential of the company to clear off its debts with the help of current assets. On the other hand, the acid test ratio, also called the quick ratio, is the ratio that excludes inventory while evaluating the liquidity of the company, as inventory is considered to be a less liquid current asset in comparison to others.
  • Current ratio is computed by dividing current assets by the current liabilities, while acid test ratio is calculated by dividing quick assets by current liabilities. Here, quick assets mean current assets minus inventories.
  • The working capital ratio of 2:1 is regarded as desirable, which means that there are two assets to cover each liability. Whereas, in the case of acid test ratio, a ratio of 1:1 is satisfactory. However, if the value is significantly less than 1, it implies that the company has a large amount of its cash tied up in productive assets, so the company may struggle to raise money in the short term.
  • Current ratio is suitable for all types of companies, whereas the acid test ratio is suitable for companies holding a significant amount of inventory.
03

Similarities between acid-test ratio and a current ratio

The acid test ratio is similar to the current ratio as both are considered to be liquidity analysis ratios because they highlight the liquidity of the company. The acid test ratio is used to ascertain whether the value of the company鈥檚 short assets is capable enough to cover its short-term liabilities. Likewise, the current ratio is also used to ascertain the company鈥檚 ability to meet its short-term liabilities.

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Most popular questions from this chapter

Question: E13-1 (L01) (Balance Sheet Classification of Various Liabilities) How would each of the following items be reported on the balance sheet? (a) Accrued vacation pay. (j) Premium offers outstanding. (b) Estimated taxes payable. (k) Discount on notes payable. (c) Service warranties on appliance sales. (l) Personal injury claim pending. (d) Bank overdraft. (m) Current maturities of long-term debts to be paid (e) Employee payroll deductions unremitted. from current assets. (f) Unpaid bonus to officers. (n) Cash dividends declared but unpaid. (g) Deposit received from customer to guarantee (o) Dividends in arrears on preferred stock. performance of a contract. (p) Loans from officers. (h) Sales taxes payable. (i) Gift certificates sold to customers but not yet redeemed.

Question: At what amount should trading, available-for-sale, and held-to-maturity debt securities be reported on the balance sheet?

BE13-11 (L03) Buchanan Company recently was sued by a competitor for patent infringement. Attorneys have determined that it is probable that Buchanan will lose the case and that a reasonable estimate of damage to be paid by Buchanan is \(300,000. In light of this case, Buchanan is considering establishing a \)100,000 self-insurance allowance. What entry(ies), if any, should Buchanan record to recognize this loss contingency?

(Available-for-Sale Debt Securities Entries and Financial Statement Presentation) At December 31, 2017, the

available-for-sale debt portfolio for Steffi Graf, Inc. is as follows.

Security Cost Fair Value Unrealized Gain (Loss)

A \(17,500 \)15,000 (\(2,500)

B 12,500 14,000 1,500

C 23,000 25,500 2,500

Total \)53,000 \(54,500 1,500

Previous fair value adjustment balance鈥擠r. 400

Fair value adjustment鈥擠r. \)1,100

On January 20, 2018, Steffi Graf, Inc. sold security A for $15,100. The sale proceeds are net of brokerage fees.

Instructions

(a) Prepare the adjusting entry at December 31, 2017, to report the portfolio at fair value.

(b) Show the balance sheet presentation of the investment-related accounts at December 31, 2017. (Ignore notes presentation.)

(c) Prepare the journal entry for the 2018 sale of security A

Greco Resort opened for business on June 1 with eight air-conditioned units. Its trial balance on August 31 is as follows.

GRECO RESORT

TRIAL BALANCE

AUGUST 31, 2017

Debit

Credit

Cash

\( 19,600

Prepaid Insurance

4,500

Supplies

2,600

Land

20,000

Buildings

120,000

Equipment

16,000

Accounts Payable

\) 4,500

Unearned Rent Revenue

4,600

Mortgage Payable

60,000

Common Stock

91,000

Retained Earnings

9,000

Dividends

5,000

Rent Revenue

76,200

Salaries and Wages Expense

44,800

Utilities Expenses

9,200

Maintenance and Repairs Expense

3,600

\(245,300

\)245,300

Other data:

  1. The balance in prepaid insurance is a one-year premium paid on June 1, 2017.
  2. An inventory count on August 31 shows \(450 of supplies on hand.
  3. Annual depreciation rates are buildings (4%) and equipment (10%). Salvage value is estimated to be 10% of cost.
  4. Unearned Rent Revenue of \)3,800 was earned prior to August 31.
  5. Salaries of \(375 were unpaid at August 31.
  6. Rentals of \)800 were due from tenants at August 31.
  7. The mortgage interest rate is 8% per year.

Instructions

(a) Journalize the adjusting entries on August 31 for the 3-month period June 1鈥揂ugust 31. (Omit explanations.)

(b) Prepare an adjusted trial balance on August 31.
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