Accounting: What the Numbers Mean 9th Edition by Wayne W McManus, Daniel F Viele, David H Marshall

Exercise 68

Assume that Kulpa Company has a current ratio of 0.7. Which of the following transactions would increase this ratio?

a. Purchasing merchandise inventory on credit.

b. Selling merchandise inventory at cost for cash.

c. Collecting accounts receivable in cash.

d. Paying off accounts payable with cash.

Step 1 of 2

Current ratio is a measure of liquidity of an organization or its ability to meet current obligations.

• A current ratio is increased when the current assets such as cash, accounts receivable or merchandise inventory are increased or when current liabilities such as accounts payable are decreased.

• The current ratio is increased by purchasing merchandise inventory on credit, since assets are increased thereby increasing the ratio.

• Current ratio shows the company ability to repay their short term obligations like accounts payable, salaries payable, dividend payable, etc. Users can understand easily company’s liquidity by using this current ratio. A higher current ratio indicates higher liquidity position of the company, and lower ratio indicates less liquidity position.

Therefore, correct option is a i.e. Purchasing merchandise inventory on credit.