CFA Practice Question
Assume that Temple Company has a current ratio of 1.75. The purchase of inventory on account would have no effect on this ratio since current assets and current liabilities would both increase by the same amount. True or False?
Correct Answer: False
Since current assets are greater than current liabilities prior to this transaction, adding the same amount to both the numerator and denominator will reduce the current ratio.
User Contributed Comments 7
| User | Comment |
|---|---|
| Pooh | Current Assets increases at a faster rate than Current Liabilities. Ratio was already greater than 1. |
| tony1973 | no pooh. When the current ratio is bigger than 1, current asset increases at a slower rate than current liabilities if both are increased by the same amount. |
| haarlemmer | Put it simple assuming original 2/1=2 now add 1 on both which then is 3/2=1.5 |
| desertfox27 | if CR is less than 1, 2/3=0.67 and now add 1 on both which is then 3/4=0.75 |
| thud | Couldn't you say it's false because if you pay inventories with cash, you don't change total assets but you change current assets? |
| mchu | Thud,in the question, it says'' on account'', which means partial debt. |
| missmalik | current ratio is 0.9 ... then increasing CA and CL with same number / percentage will increase the current ratio from 0.9 to some higher number ... if current ratio is 0.9 ... then decreasing CA and CL with same number / percentage will decrease the current ratio from 0.9 to some lower number ... if current ratio is 1.2 ... then increasing CA and CL with same number / percentage will decrease the current ratio from 1.2 to some lower number ... if current ratio is 1.2 ... then decreasing CA and CL with same number / percentage will increase the current ratio from 1.2 to some higher number ... |