Mitchell Corporation Has Current Assets Of $1,600,000 Million And Current Liabilities Of $750,000. If They Pay $350,000 Of Their Accounts Payable What Will Their New Current Ratio Be?
We are given the following accounting data as shown below:
Current Assets (CA)= $1,600,000
Current Liabilities (CL) = $750,000
Required New Current Ratio (CR) after making payments to accounts payable =
?
We know that current ratio is calculated by using the following formula:
Current Ratio = Current Assets / Current Liabilities
The entry to record for making payments to accounts payable by Mitchell
Corporation is to debit accounts payable account by $350,000 and credit to cash
account by $350,000 as shown below:
Accounts Payable a/c $350,000
Cash a/c $350,000
(Cash Paid To Accounts Payable During The Accounting Period)
In this entry, we debit accounts payable as the business is paying its
liability, so it is decreasing by $350,000 and as a result total current
liabilities (TCL) are also decreased with the same amount. So, we deduct
$350,000 from TCL and now we get the following as shown below:
New Balance of CL = $750,000 - $350,000 = $400,000
Cash, as a CA, is paid out, so it is decreasing and as a result, we credit it.
Due to the decrease in cash by $350,000, there is also decrease in total
current assets by $350,000. So, the new balance of CA will be shown below:
New Balance of CA = $1,600,000 - $350,000 = $1,250,000
By putting the values of CA and CL in the current ratio formula, we have:
Current Ratio = $1,250,000 / $400,000 = 3.1:1
So, the Mitchell Corporation has more CA than its CL to pay its short-term
obligations. This CR shows that for 1 value of current liabilities, the
corporation has 3.1 values of current assets to cover its short-term obligations
for the smooth flowing of the business.
The other options (b, c and d) of this mcq are wrong choices here.
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