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Chapter 5: 5 (page 237)

Perez Company reported an increase in inventories in the past year. Discuss the effect of this change on the current ratio (current assets ÷ current liabilities). What does this tell a statement user about Perez Company’s liquidity?

Short Answer

Expert verified

The current ratio and liquidity of the company will increase with the increase in inventory.

Step by step solution

01

Definition of Current Ratio

The financial metric reflecting the liquidity position of the business entity by comparing the current obligation and resources is known as the current ratio.

02

Change in Current Ratio

Due to an increase in the inventories of the business entity, the current assets of the business entity will also increase. An increase in current assets will increase the current ratio because thecurrent assets are reported as the numerator in calculating the current ratio.

03

Liquidity of the Company

The current ratio provides information about the company’s liquidity. Due to an increase in the current ratio due to an increase in inventory, the company’s liquidity will also increase as more current assets will be available for paying current liabilities.

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Most popular questions from this chapter

Hawthorn Corporation’s adjusted trial balance contained the following accounts at December 31, 2017: Retained Earnings \(120,000, Common Stock \)750,000, Bonds Payable \(100,000, Paid-in Capital in Excess of Par—Common Stock \)200,000, Goodwill \(55,000, Accumulated Other Comprehensive Loss \)150,000, and Noncontrolling Interest $35,000. Prepare the stockholders’ equity section of the balance sheet.

Sergey Co. has net cash provided by operating activities of \(1,200,000. Its average current liabilities for the period are \)1,000,000, and its average total liabilities are $1,500,000. Comment on the company’s liquidity and financial flexibility, given this information.

Case 4: Amazon.com The incredible growth of Amazon.com has put fear into the hearts of traditional retailers. Amazon’s stock price has soared to amazing levels. However, it is often pointed out in the financial press that it took the company several years to report its first profit. The following financial information is taken from a recent annual report.

(\( in millions)

Current year

Prior year

Current assets

\)31,327

$24,625

Total assets

54,505

40,159

Current liabilities

28,089

22,980

Total liabilities

43,764

30,413

Cash provided by operations

6,842

5,475

Capital expenditures

4,893

3,444

Dividend paid

0

0

Net income (loss)

(241)

274

Sales

88,988

74,452

Instructions

(a) Calculate free cash flow for Amazon for the current and prior years, and discuss its ability to finance expansion from internally generated cash. Thus far Amazon has avoided purchasing large warehouses. Instead, it has used those of others. It is possible, however, that in order to increase customer satisfaction, the company may have to build its own warehouses. If this happens, how might your impression of its ability to finance expansion change?

(b) Discuss any potential implications of the change in Amazon’s cash provided by operations from the prior year to the current year.

(Presentation of Property, Plant, and Equipment) Carol Keene, corporate comptroller for Dumaine Industries, is trying to decide how to present “Property, plant, and equipment” in the balance sheet. She realizes that the statement of cash flows will show that the company made a significant investment in purchasing new equipment this year, but overall she knows the company’s plant assets are rather old. She feels that she can disclose one figure titled “Property, plant, and equipment, net of depreciation,” and the result will be a low figure. However, it will not disclose the age of the assets. If she chooses to show the cost less accumulated depreciation, the age of the assets will be apparent. She proposes the following.

Particular

Amount \(

Property, Plant, and Equipment (net of depreciation)

\)10,000,000

Rather than

Particular

Amount \(

Property, Plant, and Equipment

\)50,000,000

Less: Accumulated depreciation

(40,000,000)

Net book value

$10,000,000

Instructions

Answer the following questions.

(a) What are the ethical issues involved?

(b) What should Keene do?

According to generally accepted accounting principles, what is the balance sheet valuation of each of the following assets?

(a) Trade accounts receivable.

(b) Land.

(c) Inventories.

(d) Trading securities (common stock of other companies).

(e) Prepaid expenses.
See all solutions

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