ExpertMedium1 markMultiple Choice
ACCA · Question 63 · Interpretation of financial statements
Section B - Case 2: Single Entity Accounts & Ratio Analysis
*Scenario: Horizon Wind Farms Ltd has prepared draft financial statements for the year ended 31 December 20X8. The draft net profit is $850,000. Draft Revenue is $4,000,000 and Cost of Sales is $2,200,000. The following adjustments have not yet been processed:
- Depreciation on new turbines of $50,000 was omitted.
- An annual insurance premium of $12,000 paid on 1 July 20X8 was expensed in full.
- Closing inventory was overvalued by $30,000.
- An irrecoverable debt of $15,000 needs to be written off.
Equity comprises Share capital $1,000,000 and Retained earnings $2,000,000. There is a long-term loan of $1,500,000.*
What is the specific effect of writing off the $15,000 irrecoverable debt on the Current Ratio?
Section B - Case 2: Single Entity Accounts & Ratio Analysis
*Scenario: Horizon Wind Farms Ltd has prepared draft financial statements for the year ended 31 December 20X8. The draft net profit is $850,000. Draft Revenue is $4,000,000 and Cost of Sales is $2,200,000. The following adjustments have not yet been processed:
- Depreciation on new turbines of $50,000 was omitted.
- An annual insurance premium of $12,000 paid on 1 July 20X8 was expensed in full.
- Closing inventory was overvalued by $30,000.
- An irrecoverable debt of $15,000 needs to be written off.
Equity comprises Share capital $1,000,000 and Retained earnings $2,000,000. There is a long-term loan of $1,500,000.*
What is the specific effect of writing off the $15,000 irrecoverable debt on the Current Ratio?
Answer options:
A.
It will increase the Current Ratio
B.
It will decrease the Current Ratio
C.
It will have no effect on the Current Ratio
D.
It will decrease both Current Assets and Current Liabilities equally
How to approach this question
Analyze the journal entry for writing off a debt: Dr Irrecoverable Debts Expense, Cr Trade Receivables. Trade Receivables are Current Assets. If Current Assets go down, the Current Ratio goes down.
Full Answer
B.It will decrease the Current Ratio✓ Correct
Writing off an irrecoverable debt reduces Trade Receivables, which is a component of Current Assets. Since Current Assets decrease and Current Liabilities remain unchanged, the Current Ratio (Current Assets / Current Liabilities) will decrease.
Common mistakes
Thinking an expense write-off only affects the P&L and not the Statement of Financial Position.
Practice the full ACCA FA — Financial Accounting Practice Exam 1
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