Desktop Co.presently has a current ratio of 1.2 to 1 and an acid-test ratio of 0.8 to 1.What will be effect of prepaying next year's office rent of $50,000?
A) No effect on either the company's current ratio or its acid-test ratio.
B) No effect on the company's current ratio but will decrease its acid-test ratio.
C) A decrease in both the company's current ratio and its acid-test ratio.
D) An increase in both the company's current ratio and its acid-test ratio.

Question

Quizplus · Accepted Answer

Prepaying next year's office rent of $50,000 will decrease the company's current assets (cash) without affecting its current liabilities, thus not changing the current ratio. However, since prepaid rent is not considered a quick asset, the acid-test ratio, which excludes inventory and prepaid expenses from current assets, will decrease as the numerator of the ratio (quick assets) decreases while the denominator (current liabilities) remains unchanged.