Assignment
CHAPTER 6-LIQUIDITY OF SHORT-TERM ASSETS; RELATED DEBT-PAYING ABILITY
MULTIPLE CHOICE
1. Company A uses LIFO and Company B uses FIFO for inventory valuation. Otherwise, the firms are of similar size and have the same revenue and expense. Assume inflation. In analyzing liquidity and profitability of the two firms, which of the following will hold true?
a. It is impossible to compare two firms with different inventory methods.
b. Company B will have relatively higher profit and higher inventory turnover.
c. Company B will have relatively higher profit and lower inventory turnover.
d. Company A will have a higher current ratio and acid test ratio, with the same profit.
e. Company B will have relatively higher profit and a higher current ratio.
2. Abbott Company presents the following data for 2012.
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Receivables, end of year, less allowances for losses and discounts of $115,960
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$ 2,370,100
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Receivables, beginning of year, less allowance for losses and discounts of $102,330
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2,443,140
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Net Sales
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24,417,090
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The accounts receivable turnover in times per year is:
a. 6.9.
b. 7.9.
c. 10.7.
d. 9.7.
e. 11.0.
3. If a firm has pledged its receivables and its inventory, then the best indicator of its short-term liquidity may be indicated by:
a. working capital.
b. current ratio.
c. acid-test.
d. cash ratio.
e. days' sales in receivables.
4. Which of the following does not bear on the quality of receivables?
a. Shortening the credit terms
b. Lengthening the credit terms
c. Right of return privilege
d. Lengthening the outstanding period
e. All of the answers bear on the quality of receivables
5. Which of the following ratios does not represent some form of comparison between accounts in current assets and accounts in current liabilities?
a. Working capital
b. Current ratio
c. Acid-test ratio
d. Cash ratio
e. Merchandise inventory turnover
TRUE/FALSE
1. Compensating balances reduce the amount of cash available to the borrower to meet obligations and they decrease the effective interest rate for the borrower.
2. The valuation problem from waiting to collect a receivable is ignored in the valuation of receivables and notes that are classified as current assets.
3. The receivables of a company with installment receivables would normally be considered to be of higher quality than the receivables of a company that did not have installment receivables.
4. When doing external analysis, many of the reasons why the days' sales in receivables is abnormally high or low cannot be determined without access to internal information.
5. A low sales to working capital ratio tentatively indicates an unprofitable use of working capital.
6. Management should usually strive to keep the cash ratio high.
7. In order to classify cash as a current asset, it must be free from any restrictions that would prevent its deposit or use to pay creditors classified as long-term.
8. Liquidity problems with receivables and/or inventory means that the current ratio needs to be much higher than when there are no such liquidity problems.
PROBLEM
1. Required:
Determine the cost of goods sold of a firm with the financial data given below:
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Current Ratio
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2.4 to 1
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Acid-Test Ratio*
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2.1 to 1
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Current Liabilities
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$400,000
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Inventory Turnover (using ending inventory)
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4 times
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*Assume that the acid test ratio is computed as follows: (Current Assets - Inventory) / Current Liabilities
Hint: You need to use the formulas of these ratios to solve for unknown numbers. And then, use the solved numbers to solve for the cost of goods sold.