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Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094

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BuyFindarrow_forward

Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094
Textbook Problem

Current position analysis

The bond indenture for the 10-year, 9% debenture bonds issued January 2, 20Y5, required working capital of $100,000, a current ratio of 1.5, and a quick ratio of 1.0 at the end of each calendar year until the bonds mature. At December 31, 20Y6, the three measures were computed as follows:

1. Current assets:
Cash...................................... $102,000
Temporary investments.................... 48,000
Accounts and notes receivable (net)......... 120,000
Inventories................................ 36,000
Prepaid expenses.......................... 24,000
Intangible assets.......................... 124,800
Property, plant, and equipment............. 55,200
Total current assets (net)................ $510,000
Current liabilities:
Accounts and short-term notes payable..... $ 96,000
Accrued liabilities.......................... 204,000
Total current liabilities.................. 300,000
Working capital............................. $210,000
2. Current ratio................................ 1.7 $510,000 ÷ $300,000
3. Quick ratio.............................................. 1.2 $115,200 ÷ $ 96,000

a. List the errors in the determination of the three measures of current position analysis.

b. Is the company satisfying the terms of the bond indenture? Explain.

To determine

Financial Ratios: Financial ratios are the metrics used to evaluate the capabilities, profitability, and overall performance of a company.

To list: The errors in the determination of the three measures of current position analysis.

Given info: Items of current asset and current liabilities

Explanation

In order to find the current position of a company, one need to analyze the working capital, current ratio, and acid-test ratio. Thus, in this problem, these ratios have been determined incorrectly. This is because, intangible assets and property, plant, and equipment have been included as part of current assets. But, they are non-current asset. When calculating quick assets, both numerator and denominator are incorrect. The denominator part do not include accrued liabilities. Thus, it must include both accounts and short-term notes payable and accrued liabilities. On the other hand, when numerator is concerned, it includes inventories, prepaid expenses, and property, plant, and equipment. Actually, these are not quick assets.

Current assets include cash, temporary investments, and accounts and notes receivable (net). Current liabilities include accounts and short-term notes payable. Thus, total current assets and total current liabilities are calculated below:

Current assets = (Cash + Temporary investments + Accounts and notes receivable (net) + Inventories + Prepaid expenses )=$102,000+$48,000+$120,000+$36,000+$24,000=$330,000

Current liabilities = (Accounts and short-term notes payable + Accrued liabilties)=$96,000+$204,000=$300,000

Quick Assets are those assets that are most liquid

b)

To determine
Whether company satisfies the terms of the bond indenture

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