Table of contents

1. Introduction to Accounting1h 21m
2. Transaction Analysis1h 13m
3. Accrual Accounting Concepts2h 38m
4. Merchandising Operations2h 30m
5. Inventory1h 55m
6. Internal Controls and Reporting Cash1h 16m
7. Receivables and Investments3h 8m
8. Long Lived Assets5h 1m
9. Current Liabilities2h 19m
10. Time Value of Money1h 23m
- Time Value of Money Equations
  35m
- Using Time Value of Money Tables
  47m
11. Long Term Liabilities2h 45m
12. Stockholders' Equity2h 15m
13. Statement of Cash Flows2h 24m
14. Financial Statement Analysis5h 25m
15. GAAP vs IFRS56m

14. Financial Statement Analysis

Ratios: Quick (Acid Test) Ratio

Financial Accounting

14. Financial Statement Analysis

Ratios: Quick (Acid Test) Ratio

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Multiple Choice

Which of the following is true when comparing the current ratio with the acid-test (quick) ratio?

The current ratio is always lower than the acid-test ratio because it is more conservative.

The acid-test ratio includes all current assets, while the current ratio excludes inventory.

Both ratios always yield the same value since they use the same components.

The acid-test ratio excludes inventory and prepaid expenses from current assets, making it typically lower than the current ratio.

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Verified step by step guidance

Understand the definitions of the current ratio and the acid-test (quick) ratio. The current ratio measures a company's ability to pay short-term obligations using all current assets, while the acid-test ratio is a more conservative measure that excludes inventory and prepaid expenses from current assets.

Recall the formulas for both ratios: The current ratio is calculated as \( \text{Current Ratio} = \frac{\text{Current Assets}}{\text{Current Liabilities}} \), while the acid-test ratio is calculated as \( \text{Acid-Test Ratio} = \frac{\text{Current Assets} - \text{Inventory} - \text{Prepaid Expenses}}{\text{Current Liabilities}} \).

Compare the components used in each ratio. The current ratio includes all current assets, such as cash, accounts receivable, inventory, and prepaid expenses. The acid-test ratio excludes inventory and prepaid expenses, focusing only on the most liquid assets like cash and accounts receivable.

Analyze the impact of excluding inventory and prepaid expenses. Since inventory and prepaid expenses are typically less liquid than cash and accounts receivable, excluding them makes the acid-test ratio more conservative and usually results in a lower value compared to the current ratio.

Conclude that the acid-test ratio is typically lower than the current ratio because it excludes inventory and prepaid expenses, making it a more stringent measure of liquidity.