Compute the (a) current ratio and (b) acid-test ratio.
Understand the Problem
The question is asking for the computation of both the current ratio and the acid-test ratio based on the given year-end data for Pritchett Company. To solve it, we will calculate the current assets and current liabilities to derive the ratios.
Answer
Current Ratio: $2.725$, Acid-Test Ratio: $1.075$
Answer for screen readers
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Current Ratio: $$ \text{Current Ratio} = 2.725 $$
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Acid-Test Ratio: $$ \text{Acid-Test Ratio} = 1.075 $$
Steps to Solve
- Calculate Current Assets
First, sum up all current assets. The components are:
- Cash: $20,600
- Short-term investments: $3,600
- Accounts receivable (current): $11,000
- Inventory: $35,200
- Prepaid (current) assets: $16,800
The total current assets can be calculated as: $$ \text{Current Assets} = 20,600 + 3,600 + 11,000 + 35,200 + 16,800 = 87,200 $$
- Calculate Total Current Liabilities
Next, identify total current liabilities from the given data: $$ \text{Current Liabilities} = 32,000 $$
- Compute Current Ratio
The current ratio is calculated using the formula: $$ \text{Current Ratio} = \frac{\text{Current Assets}}{\text{Current Liabilities}} $$ Substituting in our values, we have: $$ \text{Current Ratio} = \frac{87,200}{32,000} $$
- Calculate Acid-Test Ratio
To compute the acid-test ratio, we only consider the most liquid assets:
- Cash: $20,600
- Short-term investments: $3,600
- Accounts receivable (current): $11,000
The acid-test ratio is computed using: $$ \text{Acid-Test Ratio} = \frac{\text{Cash} + \text{Short-term Investments} + \text{Accounts Receivable}}{\text{Current Liabilities}} $$ This becomes: $$ \text{Acid-Test Ratio} = \frac{20,600 + 3,600 + 11,000}{32,000} $$
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Current Ratio: $$ \text{Current Ratio} = 2.725 $$
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Acid-Test Ratio: $$ \text{Acid-Test Ratio} = 1.075 $$
More Information
The current ratio indicates that for every dollar of liability, Pritchett Company has approximately $2.73 in current assets. The acid-test ratio shows that it has $1.08 in liquid assets for every dollar of current liabilities, which suggests good short-term financial strength.
Tips
- Miscalculating the total current assets or current liabilities can lead to incorrect ratio calculations.
- Forgetting to exclude inventory when calculating the acid-test ratio is a common error.
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