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Chapter 11: Problem 23

Austin Technology Co. had the following current assets and liabilities for two comparative years: \begin{tabular}{lrr} & Dec. 31, 2010 & Dec. 31, 2009 \\ \hline Current assets: & & \\ Cash & \(\$ 370,000\) & \(\$ 448,000\) \\ Accounts receivable & 400,000 & 410,000 \\ Inventory & 220,000 & 180,000 \\ \(\quad\) Total current assets & \(\$ 990,000\) & \(\$ 1,038,000\) \\ \hline \end{tabular} a. Determine the quick ratio for December 31,2010 and 2009 . b. Interpret the change in the quick ratio between the two balance sheet dates.

Short Answer

Expert verified
The quick ratio decreased from 2009 to 2010, indicating reduced liquidity and reliance on inventory for short-term obligations.

Step by step solution

01

Understanding the Quick Ratio Formula

The quick ratio is a measure of a company's ability to meet its short-term obligations using its most liquid assets. The formula for the quick ratio is: \[ \text{Quick Ratio} = \frac{\text{Cash} + \text{Accounts Receivable}}{\text{Current Liabilities}} \] This excludes inventory from the numerator, focusing on the most liquid assets.
02

Calculate Quick Ratio for 2009

In 2009, the quick assets (cash and accounts receivable) are \(448,000 + 410,000 = 858,000\). We do not have the exact figure for current liabilities, so it is important to establish them as 'Current Liabilities 2009' for later calculations.Thus, the quick ratio for 2009 is: \[ \text{Quick Ratio 2009} = \frac{858,000}{\text{Current Liabilities 2009}} \]
03

Calculate Quick Ratio for 2010

For 2010, the quick assets are \(370,000 + 400,000 = 770,000\). Again, without specific current liabilities data, the equation establishes them as 'Current Liabilities 2010'.So, the quick ratio for 2010 is: \[ \text{Quick Ratio 2010} = \frac{770,000}{\text{Current Liabilities 2010}} \]
04

Analyze the Quick Ratio Change

If the quick ratio decreases over the two years, it indicates reduced liquidity, potentially suggesting growing reliance on inventory to meet obligations. Hence, assuming equal growth in liabilities, a decrease from 2009 to 2010 implies a tighter liquidity position.
05

Conclude with Given Data

Without exact current liabilities, assume comparable changes in liabilities each year. Thus, the decreased cash flow and accounts receivable relative to 2009 suggest weakened ability to quickly cover liabilities without inventory in 2010.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Liquidity
Liquidity is a measure of how easily a company's assets can be converted into cash when needed. This concept is vital because it gives an insight into a business's ability to quickly meet its short-term obligations.
Liquidity focuses on cash and other assets that can be transformed into cash fairly swiftly. The Quick Ratio is one common measure of liquidity, as it evaluates how efficiently a company can use its liquid assets to extinguish its current liabilities.
It specifically pays attention to assets like cash and accounts receivable while excluding inventory, since inventory might take longer to liquidate. Companies with strong liquidity are often seen as more financially stable, as they can weather short-term financial difficulties.
Current Assets
Current assets are resources that are expected to be converted into cash or used up within a year. They are essential in analyzing a business's short-term financial health.
Key components of current assets include:
  • Cash - the most liquid asset providing immediate solvency.
  • Accounts receivable - funds owed by customers, anticipated to be collected soon.
  • Inventory - merchandise intended for sale, although less liquid compared to cash and accounts receivable.
The efficient management of current assets ensures that a company can sustain its daily operations and cover short-term debts. Reducing excess inventory and improving collection of accounts receivable can enhance a firm鈥檚 liquidity.
Financial Analysis
Financial analysis involves reviewing and evaluating a company's financial statements to make informed business decisions. It helps stakeholders understand the complete financial picture of a company.
With regard to liquidity, as reflected in the Quick Ratio, financial analysis allows us to identify trends and potential red flags in a company鈥檚 ability to pay off its current debts without relying on less liquid assets.
By comparing financial data, such as the quick assets and liabilities over multiple years, analysts can detect variations in liquidity, offering insights into the underlying reasons for any changes. This can influence decisions related to investment, management strategies and lending agreements.
Accounts Receivable
Accounts receivable represents money that customers owe to a company for products or services that have been delivered but not yet paid for. It is an integral part of the liquidity calculation.
As a short-term asset, it is anticipated to be converted to cash within a year, making it vital apart from liquid assets highlighted in the Quick Ratio.
Managing accounts receivable efficiently includes:
  • Prompt invoicing to clients.
  • Regularly following up on overdue accounts.
  • Implementing credit policies that encourage timely payments.
Maintaining healthy accounts receivable levels reinforces cash flow and thereby strengthens a company鈥檚 financial standing by contributing positively to the liquidity metrics.

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Most popular questions from this chapter

Several months ago, Welker Chemical Company experienced a hazardous materials spill at one of its plants. As a result, the Environmental Protection Agency (EPA) fined the company \(\$ 410,000\). The company is contesting the fine. In addition, an employee is seeking \(\$ 400,000\) damages related to the spill. Lastly, a homeowner has sued the company for \(\$ 260,000\). The homeowner lives 30 miles from the plant, but believes that the incident has reduced the home's resale value by \(\$ 260,000\). Welker's legal counsel believes that it is probable that the EPA fine will stand. In addition, counsel indicates that an out-of-court settlement of \(\$ 170,000\) has recently been reached with the employee. The final papers will be signed next week. Counsel believes that the homeowner's case is much weaker and will be decided in favor of Welker. Other litigation related to the spill is possible, but the damage amounts are uncertain. a. Journalize the contingent liabilities associated with the hazardous materials spill. Use the account "Damage Awards and Fines" to recognize the expense for the period. b. Prepare a note disclosure relating to this incident.

According to a summary of the payroll of Scofield Industries Co., \(\$ 600,000\) was subject to the \(6.0 \%\) social security tax and \(\$ 740,000\) was subject to the \(1.5 \%\) Medicare tax. Also, \(\$ 20,000\) was subject to state and federal unemployment taxes. a. Calculate the employer's payroll taxes, using the following rates: state unemployment, \(4.2 \%\); federal unemployment, \(0.8 \%\). b. Journalize the entry to record the accrual of payroll taxes.

In a recent year's financial statements, Procter \& Gamble showed an unfunded pension liability of \(\$ 2,637\) million and a periodic pension cost of \(\$ 183\) million. Explain the meaning of the \(\$ 2,637\) million unfunded pension liability and the \(\$ 183\) million periodic pension cost.

The payroll register for Gentry Company for the week ended December 17 indicated the following: \(\begin{array}{lr}\text { Salaries } & \$ 540,000 \\ \text { Social security tax withheld } & 25,380 \\ \text { Medicare tax withheld } & 8,100 \\ \text { Federal income tax withheld } & 108,000\end{array}\) In addition, state and federal unemployment taxes were calculated at the rate of \(5.2 \%\) and \(0.8 \%\), respectively, on \(\$ 10,000\) of salaries. a. Journalize the entry to record the payroll for the week of December 17 . b. Journalize the entry to record the payroll tax expense incurred for the week of December \(17 .\)

Kailua Motors is a small manufacturer of specialty electric motors. The company employs 26 production workers and 7 administrative persons. The following procedures are used to process the company's weekly payroll: a. All employees are required to record their hours worked by clocking in and out on a time clock. Employees must clock out for lunch break. Due to congestion around the time clock area at lunch time, management has not objected to having one employee clock in and out for an entire department. b. Whenever a salaried employee is terminated, Personnel authorizes Payroll to remove the employee from the payroll system. However, this procedure is not required when an hourly worker is terminated. Hourly employees only receive a paycheck if their time cards show hours worked. The computer automatically drops an employee from the payroll system when that employee has six consecutive weeks with no hours worked. c. Whenever an employee receives a pay raise, the supervisor must fill out a wage adjustment form, which is signed by the company president. This form is used to change the employee's wage rate in the payroll system. d. Kailua Motors maintains a separate checking account for payroll checks. Each week, the total net pay for all employees is transferred from the company's regular bank account to the payroll account. e. Paychecks are signed by using a check-signing machine. This machine is located in the main office so that it can be easily accessed by anyone needing a check signed. State whether each of the procedures is appropriate or inappropriate after considering the principles of internal control. If a procedure is inappropriate, describe the appropriate procedure.
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