4.Chapter 4 Ratio Analysis - Liquidity Ratios, Assignment # 4

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Task 

Assignment # 4 

Hint :Refer to Question 4 & 5 of the previous assignment # 3

Ques. 1

The current ratio of a company is 2:1. State giving reasons which of the following transactions would improve, reduce and not change the current ratio:

1. Payment of dividend.
2. Redeemed 9% debentures of 100000 at a premium of 10%.
3. Received from debtors 17000.
4. Issued Rs.200000 equity shares to the vendors of machinery.
5. Accepted bills of exchange drawn by the creditors 7000.
6.. Discounted a bill receivable of Rs. 10,000 from bank. bank charged discount of Rs. 200.
7. A bill receivable Rs. 8000 discounted with bank was dishonoured.
8. Cash deposited into Bank 7000. 

Ques. 2

Quick ratio of a company is 1:1. State with reason whether the following transactions will increase ,decrease or not change the ratio :

1. Purchase of goods for cash.
2. Bills payable paid at maturity.
3.  Sale of goods costing Rs.18000 for Rs. 16000.
4. Cash collected from debtors.
5. Purchase of loose tools Rs. 2000.
6. Sale of goods on credit 3000. 

7. Payment of dividend. 

Task 

Match your Answers with the Solution to Assignment # 4 given below:

Ques. 1

1. Payment of dividend - Effect: decrease or reduce in ratio.

Reason: current assets will decrease without any change in the current liabilities.
Explanation: assume that 5000 is given by way of dividend. It will reduce the current assets to 45000 without any change in the current liabilities. The new ratio will be 1.8:1 (45000 / 25000). Hence, it has decreased.

2. Redeemed 9% debentures of rupees 10000 at a premium of 10%-  Effect: increase or improve the ratio.
 Reason: both current assets and current liabilities decrease by rupees 11000.
Explanation: redemption of debentures will decrease cash and cash equivalents and current maturities to long term borrowings (which is the part of other current liabilities.) 

3.Received from debtors rupees 17,000. Effect: not change.
Reason: it will increase cash and decrease debtors with the same amount. No change in current assets and current liabilities. 

4. Issued rupees 200000 equity shares to the vendors of machinery. Effect: not change.
Reason: both current assets and current liabilities are not affected.

5 . Accepted bills of exchange drawn by the creditors rupees 7000.  Effect: not change.
Reason: no change in current assets and current liabilities.
Explanation:Because increase in one current liability (bills payable )results in decrease in another current liability (creditors ) with the same amount.

6. Discounted a bills receivable of rupees 20000 from Bank. Banker's discount rupees 200.
Effect: decrease or reduce the ratio. 
Reason: current assets will decrease by 200 with no change in current liabilities.
Explanation: because cash and cash equivalents will increase by 9800 only whereas trade receivables decrease by rupees 10000.

7. A Bill receivable rupees 8000 discounted with bank was dishonoured. Effect: not change.
Reason: both current assets and current liabilities are not affected. 
Explanation: cash and cash equivalents decrease by rupees 8000 due to payment made to the bank, whereas trade receivables increase by 8000. So current assets remain the same. Whereas, current liabilities are not affected at all.

8.Cash deposited into Bank rupees 7000. Effect: not change.
Reason: both current assets and current liabilities are not affected. 
Explanation: cash and cash equivalents remain the same because cash balance decreases and bank balance increases. So, current assets remain the same. Whereas, current liabilities are not affected at all.


Ques. 2

1. Purchase of goods for cash.  Effect: decrease in the ratio.
Reason: quick assets is decreasing where as current liabilities will remain the same. (note that quick assets decrease by the amount of cash purchase, while increase in inventories is not included in quick assets. )

2. Bills payable paid at maturity. Effect: No change.
Reason: Since quick assets and current liabilities are decreasing by the same amount and the quick ratio is 1, it will remain the same i.e. 1:1

3. Sale of goods costing rupees 18000 for rupees 16000.  Effect: increase in the ratio.
Reason: quick assets is increasing and current liabilities remain the same. (Cash / debtors will increase by 16000 so there is increase in value of quick asset. Decrease in inventories by rupees 18000 is not considered for calculating quick ratio as quick assets exclude inventories.

4.Cash collected from debtors.  Effect: No change.
Reason: Neither quick assets nor current liabilities are changing.( Note that cash balance is increasing and debtors are decreasing by the same amount. So, value of quick asset remains the same. However ,there is no effect on current liabilities.)

5.Purchase of loose stools rupees 2000.  Effect: decrease in the ratio.
Reason: quick assets have decreased but current liabilities has not changed. (Cash decreased by rupees 2,000 but loose tools are not included in quick asset. So, quick assets decrease by rupees 2000. However there is no effect on current liabilities.)

6. Sale of goods on credit rupees 3000.  Effect: increase in the ratio.
Reason: quick assets have increased but current liabilities have not changed. (Cash Increases in case of cash sales or debtors increase in case of credit sales. So, in either case quick assets increase by rupees 3000. However there is no effect on current liabilities.)

7. Payment of dividend.  Effect: Decrease in the ratio.
Reason: quick Assets have decreased but current liabilities have not changed.