During June 2005, Bextra Inc. recorded sales of $55,000 but only $20,000 was collected in cash from customers. Cost of goods sold of $38,000. What was the effect of these sales on Bextra's current ratio?

A- Current ratio increases
B-Current ratio decreases
C-Current ratio remains unchanged
D-Insufficient information provided to judge effect on current ratio


I believe the answer is d, because it does not provided any information as to the current liabilities. Any advise on this please.

Libilities increased by 35,000 ($55,000 sales - $20,000 collected)

Assets had a $20,000 increase (cash collected from the sale) and a Decrease of $38,000 from inventory (cost of goods sold) for a net decrease of $18,000

Now you have the information needed to figure out the correct answer.

S you are saying that current ratio decreased B and is it liabilities that increased or accounts receivables.

I forgot to mention that accounts receivable had an increase of $35,000, which means that assets increased $55,000 in total.

I would agree with that. The information given all relates to the movement in current assets. So without any information on current liabilities it is not possible to say what the effect on the current ratio is.

Sorry about my first post. I did not think through the problem and I was in a hurry.

Starting with the basics. The current ratio is current assets divided by current liabilities.

Now based on the information given, your journal enty to record the sales will be:
Debit Cash (current asset) for 20,000
Debit Accounts Receivable (current asset) for 35,000
Credit Sales Revenue (Income statement account) for 55,000

The journal entry to record the cost of sales will be:
Debit Cost of Goods Sold (income statement account) for 38,000
Credit Merchandise inventory (current asset) for 38,000

Now based on this information current assets will increase because 55,000 - 38,000 will be a positive number, while current liabilities will remain unchanged.

Since your current assets increases while current liabilities reamian unchanged, your current ratio will increase.

To prove this use random numbers to get your current ratio. So current assets of 100,000 divided by 50,000 will be a 2 to 1 ratio.

Now increase your current assets to 150,000 divided by current liabilites of 50,000 will be a 3 to 1 ratio.

So when current assets increases while current liabilities remain unchanged, then the current ratio increases.

The trouble with that is that it assumes liabilities haven't changed when, from the information given, we don't actually know whether liabilities have increased, decreased or remained unchanged, because no information has been given in that respect.

What we can see is that current assets have increased. What we can't see is what effect that has on the current ratio because we don't have any information with regards to liabilities. So, by the process of elimination:

* for (a) to be correct, current liabilities would either need to remain unchanged or have decreased - which would be an assumption since we don't have the information to be sure.

* for (b) to be correct, current liablities would have to have increased over the increase in current assets - which would be an assumption since we don't have the information to be sure.

* for (c) to be correct, current liabilities would have to have increased by the same amount as current assets - which would be an assumption since we don't have the information to be sure.

* for (d) to be correct, there needs to be insufficient information to conclude that the correct answer is (a), (b) or (c).

Since we don't have any information at all about any movement in current liabilities, the logical answer is (d).

Based on the information provided in the original post the correct answer is: Current ratio increases because you are increasing current assests while current liabilities remains unchanged. The recording of sales and COGS does not involve current liabilities.

None of the information given references current liabilities - nor states that current liabilities remain unchanged. Therefore, in the absence of information related to current liabilities, it is not possible to say what the effect of an increase in current assets is on the current ratio.

To deduce that, we need to know about any movement on current liabilities as well. In particular, any new inventory on credit and payments to suppliers will cause a movement on liabilities. Therefore, if the question doesn't tell us anything about any movement in current liabilities, then we cannot say what effect an increase in current assets has on the current ratio because we don't have the information with regards to current liabilities to do the calculation.

To calculate the current ratio, we need to know the value of current assets & current liabilities. If we only know one side of the story, then it's not possible to do the calculation.

We could turn the question on its head so that current liabilities increased or decreased, with no mention of current assets, and still we wouldn't be able to say what the effect on the current ratio was because we've had no information on the movement in current assets to compare it with.

Thank you for your responses Pready and Fidget1

Ambiguously-worded question.

"What was the effect of these sales on Bextra's current ratio?" (emphasis mine).

My snap reaction to the wording is that the author is contemplating solely the immediate, direct effect "of these sales", meaning an increase of 17K in the current ratio's numerator, and nothing else.

But in a "going concern" mindset, sales also generate secondary effects, such as the need for replenishment of inventory (which, in the mind of a manager intent on sticking to his purchasing policies, probably implies a tertiary effect of incurring some additional vendor payables). Secondary and tertiary effects are still "effects".

I'd probably put money on the author intending only the immediate, direct effect of the sales to be considered, but I wouldn't risk serious money on that stand. Grace123Mercy, try to find examples in your text showing similar problems, and see if they show the author taking the "direct effects only" approach, or a broader "consider everything but the kitchen sink" approach.

I hope Grace lets us know what the actual answer is if she finds out. I'm quite intrigued.

I still think d) is the logical answer, but whether that's on the same wavelength as whoever set the multiple choice question in the first place is another matter.