Tag: elements of accounts

Questions Related to elements of accounts

Which of the following is normally treated as a satisfactory ratio of current assets to current liabilities?

elements of accounts ratio analysis liquidity ratios accounting ratio's accounting ratios

  1. $1 : 1$

  2. $2 : 1$

  3. $3 : 1$

  4. $1 : 2$

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Correct Option: B
Explanation:

The rule of thumb for a satisfactory current ratio is $2 : 1$. Let Current assets be $Rs. 100000$ and the Current liabilities be $Rs. 40000$

Now, Current ratio = Current assets/ Current liabilities
                                = $100000/40000$
                                = $2.5 : 1$ . 
This current ratio is satisfactory as it shows that the current assets available are $2.5$ times the amount of current liabilities.

Which of the following items is not taken into account when computing current ratio?

elements of accounts ratio analysis liquidity ratios accounting ratio's accounting ratios

  1. Sundry Creditors.

  2. Sundry Debtors.

  3. Bank Overdraft.

  4. Furniture.

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Correct Option: D
Explanation:

Current ratio = Current assets/ Current liabilities
Current assets include inventories, sundry debtors, cash and bank balances,receivables, loans and advances, disposable investments etc.
Current liabilities include creditors, short term loans, bank overdraft, cash credit, provisions, outstanding expenses etc.
Furniture is a fixed asset and it is not included in current assets. Hence while calculating the current ratio furniture is not taken into account.                  

A person whose assets are less than business liabilities is known as insolvent.

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  1. True

  2. False

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Correct Option: A
Explanation:

A person or firm whose liabilities exceed the value of owned assets is termed as insolvent. It is the inabilities of the company or person to pay liabilities as they become due. 

Cash in hand is the __________asset.

elements of accounts ratio analysis liquidity ratios accounting ratio's accounting ratios

  1. Least liquid

  2. Most liquid

  3. Fixed assets

  4. Intangible asset

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Correct Option: B
Explanation:

Quick ratio is the ratio of quick (or liquid) asset to current liabilties. It is expressed as:

                       Quick ratio = Quick Asset/Current Liabilities
The quick assets are defined as those assets which are quickly convertible into cash. While calculating quick assets we exclude the closing stock and prepaid expenses from the current assets. Because of exclusion liquid current asset, it is considered better than current ratio as a measure of liquidity position of the business. Cash on hand is the most liquid asset. It is also known as "Acid-Test Ratio".

Sale of inventory for cash will cause the current ratio to __________.

elements of accounts ratio analysis liquidity ratios accounting ratio's accounting ratios

  1. increase

  2. decrease

  3. remain unchanged

  4. none of these

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Correct Option: C
Explanation:

Current ratio = Current assets / Current liabilities

When inventory is sold for cash then, the amount of inventory decreases and simultaneously the cash balance increases and there would be no net effect on the current asset figure. And so the current ratio will remain unchanged.

Purchase of inventory on credit will cause the quick ratio to               .

elements of accounts ratio analysis liquidity ratios accounting ratio's accounting ratios

  1. increase

  2. decrease

  3. remain unchanged

  4. none of these

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Correct Option: B
Explanation:

Quick Ratio = [Current assets minus Inventory] / Current liabilities

Let Current assets = $Rs. 100000$, Inventory = $Rs. 20000$ and Current liabilities = $Rs. 40000$
 So Quick Ratio = [$100000-20000] / 40000$ = $2 : 1$
Now let inventory purchased on credit be $Rs. 20000$, so revised Inventory = $Rs. 60000$ and Current liabilities = $Rs. 60000$
Revised Quick Ratio =[$100000-60000] / 60000$ = $2 : 3$
So , Purchase of inventory on credit will cause the quick ratio to decrease.

Which of the following transactions will change the current ratio?

elements of accounts ratio analysis liquidity ratios accounting ratio's accounting ratios

  1. Purchase of goods for cash.

  2. Plant acquired on account.

  3. Sold goods on credit.

  4. Debentures converted into equity capital.

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Correct Option: B
Explanation:
  1. When goods are purchased for cash the stock would increase and the cash balance would decrease and so there would be no effect on the current ratio.
  2. When plant is acquired on account the fixed asset would increase and there would be increase in the creditors amount, hence the current ratio would decrease.
  3. When goods are sold on credit the stock would decrease and the debtors would increase and hence there would be no effect on current ratio.
  4. When debentures are converted into equity capital there would be no changes in current assets and current liabilities  and so no change in current ratio.

The immediate solvency ratio is                 .

elements of accounts ratio analysis liquidity ratios accounting ratio's accounting ratios

  1. quick ratio

  2. current ratio

  3. stock turnover ratio

  4. debtor turnover ratio

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Correct Option: A
Explanation:

Quick Ratio = [Current Assets- Inventory] / [Current liabilities - Bank Overdraft and Cash credit]

While calculating quick ratio we reduce the amount of inventory as it is less liquid than the other current assets. The reason to reduce the amount of bank overdraft and cash credit is that mostly these are secured against inventory. So quick ratio gives us an immediate solvency ratio and is a much more conservative ratio than current ratio.

Current ratio is increased by :
1) Issue of redeemable debentures.
2) Selling of old machine for cash.
3) Converting debentures into equity capital.
4) Cash received from debtors.

elements of accounts ratio analysis liquidity ratios accounting ratio's accounting ratios

  1. 1, 2 and 4

  2. 3 and 4

  3. 1 and 2

  4. 4 only

Show answer
Correct Option: C
Explanation:

Current ratio = Current assets/ Current liabilities

  1. When Redeemable debentures are issued, long term liabilities and the current assets increase,while  the current liabilities remain constant so  the current ratio would increase.
  2. When old machine is sold for cash, fixed assets would decrease and the current assets would increase, while  the current liabilities remain constant so  the current ratio would increase.
  3. When debentures are converted into equity capital there would be no changes in the current assets and the current liabilities and ultimately no change in the current ratio.
  4. When cash is received from debtors there would be no net changes on the current assets as the cash balance would increase and the debtors balance would decrease by the same amount and hence there would no change in the current ratio.

Current ratio may be increased by                    .

elements of accounts ratio analysis liquidity ratios accounting ratio's accounting ratios

  1. Overstating the current assets

  2. Overstating the current liabilities

  3. Understating current assets

  4. None of these

Show answer
Correct Option: A
Explanation:

Current ratio = Current assets/ current liabilities

So when current assets = $Rs 150000$ and current liabilities = $Rs. 100000$ then,
Current ratio = $100000 / 50000$
                       = $2 : 1$
Now if we overstate the current assets by $Rs. 50000$ then ,
Revised Current ratio = $150000/50000$
                                     = $3: 1 $
So, the current ratio may be increased if we overstate the current assets.