Emerald Corporation's current ratio is 0.5, while Ruby (Emerald's competitor) Company's current ratio is 1.5. Both firms want to "window dress" their coming end-of-year financial statements. As part of their window dressing strategy, each firm will double its current liabilities by adding short-term debt and placing the funds obtained in the cash account. Which of the statements below best describes the actual results of these transactions?
A)The transactions will have no effect on the current ratios.
B)The current ratios of both firms will be increased.
C)The current ratios of both firms will be decreased.
D)Only Emerald Corporation's current ratio will be increased.
E)Only Ruby Company's current ratio will be increased.

Question

Quizplus · Accepted Answer

Doubling the current liabilities while adding the same amount to current assets (cash) will increase the current ratio for a company with a current ratio of less than 1 (like Emerald Corporation, with a current ratio of 0.5) because the proportional increase in current assets will be greater than the proportional increase in current liabilities. For a company with a current ratio greater than 1 (like Ruby Company, with a current ratio of 1.5), this action will not increase the current ratio because the proportionate increase in assets equals the proportionate increase in liabilities, maintaining or potentially decreasing the ratio depending on the initial balance of current assets to current liabilities.

Emerald Corporation's Current Ratio Is 0