Amram Company\'s current ratio is 1.9. Considered alone, which of the following

Question

Amram Company's current ratio is 1.9. Considered alone, which of the following actions would reduce the company's current ratio?

Use cash to reduce accounts payable.

Borrow using short-term notes payable and use the proceeds to reduce accruals.

Borrow using short-term notes payable and use the proceeds to reduce long-term debt.

Use cash to reduce accruals.

Use cash to reduce short-term notes payable.

Use cash to reduce accounts payable.

Borrow using short-term notes payable and use the proceeds to reduce accruals.

Borrow using short-term notes payable and use the proceeds to reduce long-term debt.

Use cash to reduce accruals.

Use cash to reduce short-term notes payable.

Explanation / Answer

Current ratio invovles current assets and current liabilities. We will examine each case individually

Using Cash to pay off accounts payable and accruals would result in decrease in both cash and accounts payable/accruals in a one to one ratio. In our example, numerator is greater than denominator, so a reduction in denominator would result in increase in ratio even if the asset is reduced by the same amount. For eg:

Suppose current assets = 190000 and current liabilties = 100000

So current ratio = 1.9

Now suppose cash is paid to reduce payable by 50000

Revised current assets = 140000 and revised current liability = 50000

So now current ratio = 2.8(140000 / 50000)

Hence by paying cash to reduce accounts payable/accruals/ short term notes payable would have the increasing effect on current ratio as expalined above.

By borrowig from short term notes payable and reducing the proceeds to reduce accruals will keep the current liabilities unchanged as both are current liabilites.Hence current ratio would be the same

By borrowing short term notes payable , current liability increases and from those proceeds if long term bond is paid it will result in current assets being unchanged(since long term dent is non current liability). So numerator is unchanged while denominator gets increased and accordingly the current ratio would decrease.

Hence c is the correct answer

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