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Chapter 13: Question 30Q (page 691)

How does the acid-test ratio differ from the current ratio? How are they similar?

Short Answer

Expert verified

The primary difference between the acid-test ratio and the current ratio is that the current ratio estimates the ability of the company to clear off its debts by using short-term assets. On the other hand, the acid-test ratio or quick ratio evaluates the ability of the company to clear its debts by using short-term assets excluding inventory.

The acid test ratio is similar to the current ratio as both highlight the liquidity of the company.

Step by step solution

01

Definition of Ratio

The ratio can be defined as the measure of one value or number in relation to another. A ratio can be expressed in various ways, including as a percentage, a fraction, a “times” figure, a number of days, a rate, or as a simple manner. Ratios are just signals or clues rather than the answers to complex questions about a company.

02

Difference between acid-test ratio and a current ratio

Acid-test ratio and current ratio can be distinguished on the following grounds:

  • Current ratio is the ratio that evaluates the potential of the company to clear off its debts with the help of current assets. On the other hand, the acid test ratio, also called the quick ratio, is the ratio that excludes inventory while evaluating the liquidity of the company, as inventory is considered to be a less liquid current asset in comparison to others.
  • Current ratio is computed by dividing current assets by the current liabilities, while acid test ratio is calculated by dividing quick assets by current liabilities. Here, quick assets mean current assets minus inventories.
  • The working capital ratio of 2:1 is regarded as desirable, which means that there are two assets to cover each liability. Whereas, in the case of acid test ratio, a ratio of 1:1 is satisfactory. However, if the value is significantly less than 1, it implies that the company has a large amount of its cash tied up in productive assets, so the company may struggle to raise money in the short term.
  • Current ratio is suitable for all types of companies, whereas the acid test ratio is suitable for companies holding a significant amount of inventory.
03

Similarities between acid-test ratio and a current ratio

The acid test ratio is similar to the current ratio as both are considered to be liquidity analysis ratios because they highlight the liquidity of the company. The acid test ratio is used to ascertain whether the value of the company’s short assets is capable enough to cover its short-term liabilities. Likewise, the current ratio is also used to ascertain the company’s ability to meet its short-term liabilities.

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Most popular questions from this chapter

Assume the same information as in IFRS 17-12 except that Roosevelt has an active trading strategy for these bonds.

The fair value of the bonds at December 31 of each end-year is as follows.

2017 \(534,200 2020 \)517,000

2018 \(515,000 2021 \)500,000

2019 $513,000

Instructions

(a) Pepare the journal entry at the date of the bond purchase.

(b) Prepare the journal entries to record the interest revenue and recognition of fair value for 2017.

(c) prepare the journal entry to record the recognition of fair value for 2018.


Question: 13-17 (L04) (Ratio Computations and Discussion) Sprague Company has been operating for several years, and on December 31, 2017, presented the following balance sheet.

SPRAGUE COMPANY
BALANCE SHEET
DECEMBER 31, 2017

Cash

\(40,000

Accounts payable

\)80,0000

Receivables

\(75,0000

Mortgage payable

\)140,000

Inventory

\(95,000

Common stock (\)1 par)

\(150,000

Plant assets (net)

\)220,000

Retained earnings

\(60,000

\)430,000

\(430,000

The net income for 2017 was \)25,000. Assume that total assets are the same in 2016 and 2017.

Instructions

Compute each of the following ratios. For each of the four, indicate how it is computed and its significance as a tool in the analysis of the financial soundness of the company.

(a) Current ratio. (C) Debt to assets ratio.

(b) Acid-test ratio. (d) Return on assets.

A typical provision is:

(a) bonds payable (c) a warranty liability

(2) cash (d) accounts payable

BE13-1 (L01) Roley Corporation uses a periodic inventory system and the gross method of accounting for purchase discounts. On July 1, Roley purchased \(60,000 of inventory, terms 2/10, n/30, FOB shipping point. Roley paid freight costs of \)1,200. On July 3, Roley returned damaged goods and received credit of $6,000. On July 10, Roley paid for the goods. Prepare all necessary journal entries for Roley.

BE13-4 (L01) Sport Pro Magazine sold 12,000 annual subscriptions on August 1, 2017, for $18 each. Prepare Sport Pro’s August 1, 2017, journal entry and the December 31, 2017, annual adjusting entry, assuming the magazines are published and delivered monthly.
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