Section A

A company has a current ratio of 2.0 and a quick ratio (acid test) of 0.8. The company uses cash to pay off a short-term trade payable.

What will be the effect of this transaction on the quick ratio?

Answer options:

The quick ratio will increase.

The quick ratio will decrease.

The quick ratio will remain unchanged.

The effect cannot be determined without knowing the exact amounts.

How to approach this question

Use a hypothetical example. Quick assets = $80, Current liabilities = $100 (Ratio = 0.8). Pay $20 cash. New quick assets = $60, New liabilities = $80. New ratio = 60/80 = 0.75. The ratio decreased.

Full Answer

B.The quick ratio will decrease.✓ Correct

The quick ratio is (Current Assets - Inventory) / Current Liabilities. Paying a payable reduces both cash (numerator) and payables (denominator) by the same amount. Because the initial ratio is less than 1 (0.8), subtracting the same amount from both the numerator and denominator will decrease the ratio.

Common mistakes

Assuming that paying off debt always improves liquidity ratios.

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Practice the full ACCA FA — Financial Accounting Practice Exam 5

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