ExpertHard1 markMultiple Choice
CPA · Question 07 · Area I: Financial Reporting
Orion Corp. is analyzing its liquidity. Current Assets are $500,000 (including $100,000 inventory and $20,000 prepaid expenses) and Current Liabilities are $250,000. <br/><br/>Orion pays $50,000 cash to retire a short-term note payable. What is the effect on the Current Ratio and the Quick Ratio?
Orion Corp. is analyzing its liquidity. Current Assets are $500,000 (including $100,000 inventory and $20,000 prepaid expenses) and Current Liabilities are $250,000. <br/><br/>Orion pays $50,000 cash to retire a short-term note payable. What is the effect on the Current Ratio and the Quick Ratio?
Answer options:
A.
Current Ratio: Increase | Quick Ratio: Increase
B.
Current Ratio: Decrease | Quick Ratio: Decrease
C.
Current Ratio: Increase | Quick Ratio: Decrease
D.
Current Ratio: No Change | Quick Ratio: Increase
How to approach this question
Calculate the ratios before and after the transaction. Alternatively, know the rule: If Ratio > 1, decreasing both numerator and denominator by the same amount INCREASES the ratio.
Full Answer
A.Current Ratio: Increase | Quick Ratio: Increase✓ Correct
A
**Before:**<br/>Current Assets (CA) = 500, Current Liabs (CL) = 250. CR = 2.0.<br/>Quick Assets (QA) = 500 - 100 (Inv) - 20 (Prepaid) = 380. QR = 380/250 = 1.52.<br/><br/>**Transaction:** Pay $50k cash (Decrease CA, Decrease CL).<br/><br/>**After:**<br/>CA = 450, CL = 200. CR = 450/200 = 2.25 (Increase).<br/>QA = 330, CL = 200. QR = 330/200 = 1.65 (Increase).<br/><br/>Both ratios increase.
Common mistakes
Assuming paying a liability always improves liquidity ratios without checking the math (it depends if ratio is > or < 1).
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