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AccountingNerd8
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Posted: 07 Jun 2009 at 15:40 | IP Logged  

 

I'm not really understanding this question in the Wiley book:

53. The early liquidation of a long-term note with cash affects the:

b.(correct answer) : Quick ratio to a greater degree than the current ratio.

Their explanation: Cash is included in the numerator of both the quick and current ratios.  However, a reduction in cash affects the quick ratio more than the current ratio because it is smaller. 

I'm just not gettin it..... can anyway explain it better than Wiley for me? thanks.



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TryingCPA
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Posted: 07 Jun 2009 at 16:48 | IP Logged  

Sometimes it helps to plug in numbers.  Both ratios include cash in the numerator, but the current ratio includes ALL current assets, not just Cash, Net A/R, and Marketable Equity Securities (essentially current assets exclusive of inventory) as the quick ratio does.  Therefore, the impact of paying off a long term note has a greater impact on the quick ratio because the numerator is smaller to start with.  I think what they are referring to is the percentage decrease in the ratios from the base. 

Hope this helps, someone else may be able to explain it better than me.

 



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AccountingNerd8
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Posted: 07 Jun 2009 at 19:09 | IP Logged  

2 hours later i finally get it... It probably didn't help that i didn't know that liquidation of a long-term note with cash decreases current liabilities and current assets.  Wait, wouldn't it decrease long-term liabilities because it is a long-term note????? Now i'm confused again!!!!

i shouldn't even be allowed to take this exam



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gimpy22
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Posted: 07 Jun 2009 at 19:55 | IP Logged  

AccountingNerd8,

I feel the same way when I am studying. I read something and then find myself overanalyzing to the point where it confuses me and I start to question the material.

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TryingCPA
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Posted: 07 Jun 2009 at 21:17 | IP Logged  

Hey, we've all been there.  It's easy to get so caught up in studying you start over analyze things. 

Both the current ratio and the quick ratio have CURRENT liabilities in the denominator, so the reduction in the note payable does reduce the note payable, but does not impact the calculation :)

Some #s to make up:

Current Assets (all)      200,000
Cash, Net A/R, MES      125,000

Current Liabilities        & amp; amp; amp; amp; amp; nbsp;   50,000

Say you pay off $10,000 of a long term note

Current ratio before note paid is 4 (200,000/50,000) current ratio is current assets/current liabilities

Quick ratio before note paid is    2.5 (125,000/50,000) quick ratio is cash, net ar, marketable equity securities (a number lesser than TOTAL current assets)

 

After note is paid off

Current ratio 190,000/50,000 3.8

Quick ratio 2.3

Denominator never changes because reduction is note payable is applicable to a long term liability, not a short term liability

current ratio % decrease is 4.0-3.8/4.0 = 5%

quick ratio % decrease is 2.5-2.3/2.5 =    8%, thus a greater impact on the quick ratio

hope this helps :)



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