(Learning Objectives 6: Analyzing financial ratios) This problem demonstrates the effects of transactions on the current ratio and the debt ratio of Hialeah Company. Hialeah’s condensed and adapted balance sheet at December 31, 20X6, is:
|
(In millions) |
|
|
Total current assets |
$15.5 |
|
Properties, plant, equipment, and other assets |
15.8 |
|
$31.3 |
|
|
Total current liabilities |
$ 9.2 |
|
Total long term liabilities |
5.3 |
|
Total stockholders’ equity |
16.8 |
|
$31.3 |
Assume that during the first quarter of the following year, 20X7, Hialeah completed the following transactions:
a. Paid half the current liabilities.
b. Borrowed $3 million on long term debt.
c. Earned revenue, $2.5 million, on account.
d. Paid selling expense of $1 million.
e. Accrued general expense of $0.8 million. Credit General Expense Payable, a current liability.
f. Purchased equipment for $4.2 million, paying cash of $1.4 million and signing a longterm note payable for $2.8 million.
g. Recorded depreciation expense of $0.6 million.
Required
1. Compute Hialeah’s current ratio and debt ratio at December 31, 20X6. Round to 2 decimal places.
2. Consider each transaction separately. Compute Hialeah’s current ratio and debt ratio after each transaction during 20X7, that is, 7 times.
3. Based on your analysis, you should be able to readily identify the effects of certain transactions on the current ratio and the debt ratio. Test your understanding by completing these statements with either “increase” or “decrease”:
a. Revenues usually the current ratio.
b. Revenues usually the debt ratio.
c. Expenses usually the current ratio.
d. Expenses usually the debt ratio.
e. If a company’s current ratio is greater than 1.0, as it is for Hialeah, paying off a current liability will always the current ratio.
f. Borrowing money on long term debt will always the current ratio and the debt ratio.