Compute the (a) current ratio and (b) acid-test ratio.
Understand the Problem
The question is asking to calculate the current ratio and acid-test ratio based on the provided financial data of Pritchett Company. We'll add the relevant current assets and determine the necessary ratios using the formulas for current and acid-test ratios.
Answer
Current Ratio: $2.7$, Acid-Test Ratio: $1.1$
Answer for screen readers
- Current Ratio: $2.7$
- Acid-Test Ratio: $1.1$
Steps to Solve
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Identify Current Assets
To calculate the current ratio, first sum up the current assets. The current assets for Pritchett Company are:
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Cash: $20,600
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Short-term investments: $3,600
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Accounts receivable (current): $11,000
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Inventory: $35,200
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Prepaid (current) assets: $16,000
Total current assets = $20,600 + $3,600 + $11,000 + $35,200 + $16,000.
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Calculate Total Current Assets
Now, we add the current assets together:
$$ \text{Total Current Assets} = 20,600 + 3,600 + 11,000 + 35,200 + 16,000 = 86,400 $$ -
Identify Total Current Liabilities
The total current liabilities are provided as $32,000. -
Calculate Current Ratio
The current ratio is calculated using the formula:
$$ \text{Current Ratio} = \frac{\text{Total Current Assets}}{\text{Total Current Liabilities}} $$
Substituting the values we have:
$$ \text{Current Ratio} = \frac{86,400}{32,000} $$ -
Compute Current Ratio
Evaluating this gives:
$$ \text{Current Ratio} = 2.7 $$ -
Identify Components for Acid-Test Ratio
The acid-test ratio only includes cash, short-term investments, and accounts receivable (excluding inventory and prepaid assets). Thus, we sum:
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Cash: $20,600
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Short-term investments: $3,600
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Accounts receivable (current): $11,000
Total for acid-test = $20,600 + $3,600 + $11,000.
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Calculate Total for Acid-Test Ratio
Add these amounts together:
$$ \text{Total for Acid-Test} = 20,600 + 3,600 + 11,000 = 35,200 $$ -
Calculate Acid-Test Ratio
Using the formula for acid-test ratio:
$$ \text{Acid-Test Ratio} = \frac{\text{Total for Acid-Test}}{\text{Total Current Liabilities}} $$
Substituting the values we have:
$$ \text{Acid-Test Ratio} = \frac{35,200}{32,000} $$ -
Compute Acid-Test Ratio
Evaluating this gives:
$$ \text{Acid-Test Ratio} = 1.1 $$
- Current Ratio: $2.7$
- Acid-Test Ratio: $1.1$
More Information
The current ratio indicates that for every dollar of current liabilities, Pritchett Company has $2.70 in current assets. The acid-test ratio suggests the company has $1.10 in liquid assets for every dollar of liabilities, which means it can cover its short-term obligations without selling inventory.
Tips
- Forgetting to exclude inventory and prepaid assets when calculating the acid-test ratio.
- Miscalculating the total current assets or liabilities due to incorrect additions.
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