1. Current assets:
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $102,000
Temporary investments . . . . . . . . . . . . . . . . . . . . . . . 48,000
Accounts and notes receivable (net) . . . . . . . . . . . 120,000
Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36,000
Prepaid expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24,000
Intangible assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 124,800
Property, plant, and equipment . . . . . . . . . . . . . . . 55,200
Total current assets (net) . . . . . . . . . . . . . . . . . . . $510,000
Current liabilities:
Accounts and short-term notes payable . . . . . . . $ 96,000
Accrued liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . 204,000
Total current liabilities . . . . . . . . . . . . . . . . . . . . . 300,000
Working capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $210,000
2. Current ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.7 $510,000 $300,000
3. Quick ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.2 $115,200 $ 96,000
a. List the errors in the determination of the three measures of current position analysis.
b. Is the company satisfying the terms of the bond indenture?
Answer:
a. The working capital, current ratio, and quick ratio are calculated incorrectly. The working capital and current ratio incorrectly include intangible assets and property, plant, and equipment as a part of current assets. Both are noncurrent. The quick ratio has both an incorrect numerator and denominator. The numerator of the quick ratio is incorrectly calculated as the sum of inventories, prepaid expenses, and property, plant, and equipment ($36,000 + $24,000 + $55,200). The denominator is also incorrect, as it does not include accrued liabilities. The denominator of the quick ratio should be total current liabilities.
The correct calculations are as follows:
Working Capital
$30,000
= Current Assets – Current Liabilities
= $330,000 – $300,000
Current Ratio = Current Assets
Current Liabilities
$330,000
$300,000
= 1.1
Quick Ratio = Quick Assets
Current Liabilities
$102,000 + $48,000 + $120,000
$300,000 = 0.9
b. Unfortunately, the working capital, current ratio, and quick ratio are below the minimum threshold required by the bond indenture. This may require the company to renegotiate the bond contract, including a possible unfavorable change in the interest rate.