Practice Quiz

CLEP Accounting

Category - Accounting

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Ken’s Canaries shows current assets of $150,000 and current liabilities of $75,000. If Ken uses cash to purchase canaries that will be resold, which is true of his working capital and current ratio?
  1. Current ratio increases; working capital does not change.
  2. Both remain unchanged.
  3. Current ratio increases; working capital decreases.
  4. Current ratio does not change; working capital decreases.
  5. Both will increase.
Explanation
Answer - B - Both the working capital and current ration remain unchanged if cash is used to purchase inventory.

Key Takeaway: The current ratio is the ratio of current assets to liabilities and is used to determine the likelihood of a business being able to pay its debts over the next year. In the transaction of cash for inventory, one asset is being traded for another, so the current ratio remains unchanged and the working capital remains unchanged, as well.
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