The Lux Company experiences the following unrelated events and transactions duri

Question

The Lux Company experiences the following unrelated events and transactions during Year 1. The company's existing current ratio is 2:1 and its quick ratio is 1.2:1.

1. Lux wrote off $5,000 of accounts receivable as uncollectible.
2. A bank notifies Lux that a customer's check for $411 is returned marked insufficient funds. The customer is bankrupt.
3. The owners of Lux Company make additional cash investment of $7,500.
4. Inventory costing $600 is judged obsolete when a physical inventory is taken.
5. Lux declares a $5,000 cash dividend to be paid during the first week of the next reporting period.
6. Lux purchases long-term investments for $10,000.
7. Accounts payable of $9,000 are paid.
8. Lux borrows $1,200 rom a bank and gives a 90-day 6% promissory note in exchange.
9. Lux sells a vacant lot for $20,000 that had been used in its operations.
10. A three-year insurance policy is purchased or $1,500.

Required:
Separately evaluate the immediate effect of each transaction on the company's
a. Current ratio.
b. Quick (acid-test) ratio.
c. Working capital

Explanation / Answer

1. Allowance for doubtful accounts 5000 debit
A/R 5000 credit
a.Current Ratio= Current assets/ Current Liabilities . Account receiv. is went down by 5000. So current assets went down by 5000: numerator went down by 5000. Then Current ratio went down
b.Acid-test ratio=( cash+short term investment + Net receiv)/current liabilities.
Net receiv are down by 5000, then A-t ratio is down.
c.No effect on Capital.
2. Alowance for doubtful accounts 411 debit
A/R 411 credit
The same as 1
3. Cash 7500 debit
Capital 7500 credit
a ,b up because Cash is up.
c is up because capital is up
4.Loss( from absolencense of inv) 600 debit
Inventory 600 credit
a. and b. down because inventory is down.
c. no effect.
5.Retained Earnings 5000 debit
Div Payable 5000 credit
a. a.and b. went down because current liabilities (div payab) went up.
c. went down because retained earnings went down 5000.
6. Investment 10000 debit
Cash 10000 credit
a.b.c. no efect.
7.Account Payable 9000 debit
Cash 9000 credit
a.b. no effect. assets and liab. down by the same amount. c. no effect
8. Cash 1200 debit
N/P 1200 credit
a.b. no effect: assets and liabil are up by the same amount. c. no effect
9. Cash 20,000debit
Lot 20000 credit
a. no effect-current assets up and down no change. b. is up because cash is up
c no effect.
10. Prepaid Insurance 1500 debit
Cash 1500credit
a. no effect curent assets are up and down - no change. b. is down because cash is down by 1500. c. no effect.

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