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Chapter 8: 22RQ (page 465)

How is the acid-test ratio calculated, and what does it signify?

Short Answer

Expert verified

The formula for calculating the acid-test ratio:

Acidtestratio=Cashandcashequivalent+Short-terminvestment+NetreceivablesTotalcurrentliabilities

The acid test ratio signifies the capability of the business entity to pay the current liabilities.

Step by step solution

01

Definition of Financial Ratios

The figures that are calculated by comparing various line items of the financial statement to arrive at a conclusive decision regarding liquidity, solvency, and profitability are known as financial ratios.

02

Significance

The acid test ratio is calculated using some of the current assets that can be converted into cash immediately, such as cash and equivalents, short-term investments, and net receivables. The sum of these assets is compared with the current liabilities to determine the acid test ratio.

The acid test ratio signifies whether the business entity can cover all of its current liabilities in the situation where they all become due immediately.

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Most popular questions from this chapter

Question: Consider the following transactions for TLC Company.

2018

Dec. 6 Received a \(8,000, 90-day, 9% note in settlement of an overdue accounts

receivable from Forest Music.

31 Made an adjusting entry to accrue interest on the Forest Music note.

31 Made a closing entry for interest revenue.

2019

Mar. 6 Collected the maturity value of the Forest Music note.

Jun. 30 Loaned \)14,000 cash to Washington Music, receiving a six-month, 12% note.

Oct. 2 Received a $1,000, 60-day, 12% note for a sale to ZZZ Music. Ignore Cost of

Goods Sold.

Dec. 1 ZZZ Music dishonored its note at maturity.

1 Wrote off the receivable associated with ZZZ Music. (Use the allowance

method.)

30 Collected the maturity value of the Washington Music note

Accounting for notes receivable and accruing interestCarley Realty loaned money and received the following notes during 2018.Note Date Principal Amount Interest Rate Term

(1) Apr. 1 $ 6,000 7% 1 year

(2) Sep. 30 12,000 6% 6 months

(3) Sep. 19 18,000 8% 90 days

Requirements

1. Determine the maturity date and maturity value of each note.

2. Journalize the entries to establish each Note Receivable and to record the collection ofprincipal and interest at maturity. Include a single adjusting entry on December 31, 2018, the fiscal year-end, to record accrued interest revenue on any applicable note.Explanations are not required. Round to the nearest dollar.

At January 1, 2018, Hilltop Flagpoles had Accounts Receivable of \(28,000, and Allowance for Bad Debts had a credit balance of \)3,000. During the year, Hilltop Flagpoles recorded the following:

a. Sales of \(185,000 (\)164,000 on account; \(21,000 for cash). Ignore Cost of Goods Sold.

b. Collections on account, \)135,000.

c. Write-offs of uncollectible receivables, $2,300.

Requirements

1. Journalize Hilltop’s transactions that occurred during 2018. The company uses the allowance method.

2. Post Hilltop’s transactions to the Accounts Receivable and Allowance for Bad Debts T-accounts.

3. Journalize Hilltop’s adjustment to record bad debts expense assuming Hilltop estimates bad debts as 3% of credit sales. Post the adjustment to the appropriate T-accounts.

4. Show how Hilltop Flagpoles will report net accounts receivable on its December 31, 2018, balance sheet.

Accounting for uncollectible accounts using the allowance method (aging-of-receivables) and reporting receivables on the balance sheet.

At December 31, 2018, the Accounts Receivable balance of GPS Technology is \(200,000. The Allowance for Bad Debts account has a \)24,110 debit balance. GPS Technology prepares the following aging schedule for its accounts receivable:

Age of Accounts

1–30 Days

31–60 Days

61–90 Days

Over 90 Days

Accounts Receivable

\( 65,000

\) 50,000

\(40,000

\)45,000

Estimated percent uncollectible

0.4%

3.0%

5.0%

48.0%

Requirement:

1. Journalize the year-end adjusting entry for bad debts on the basis of the aging schedule. Show the T-account for the Allowance for Bad Debts at December 31, 2018.

2. Show how GPS Technology will report its net accounts receivable on its December 31, 2018, balance sheet

The comparative financial statements of Newton Cosmetic Supply for 2018, 2017,

and 2016 include the data shown here:

2018 2017 2016

Balance sheet—partial

Current Assets:

Cash \( 80,000 \) 50,000 $ 30,000

Short-term investment 150,000 170,000 125,000

Accounts Receivable, Net 310,000 260,000 220,000

Merchandise Inventory 360,000 335,000 330,000

Prepaid Expenses 50,000 30,000 35,000

Total Current Assets 950,000 845,000 740,000

Total Current Liabilities 530,000 630,000 670,000

Income statement—partial

Net Sales (all on account) 5,850,000 5,110,000 425,000

Requirements

1. Compute these ratios for 2018 and 2017:

a. Acid-test ratio (Round to two decimals.)

b. Accounts receivable turnover (Round to two decimals.)

c. Days’ sales in receivables (Round to the nearest whole day.)

2. Considering each ratio individually, which ratios improved from 2017 to 2018 and

which ratios deteriorated? Is the trend favorable or unfavorable for the company?
See all solutions

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