Q. 3 DK Goel Accounting Ratios Solutions Class 12 CBSE (2024-25)

the solutions of Question number 3 of Accounting Ratios chapter 5 of DK Goel Class 12 CBSE (2024-25)

Current Ratio of a Company is 2 : 1. State giving reasons which of the following suggestions would improve the ratio, which would reduce it and which would not change it?

(1) Purchase of goods on credit.
(2) Purchase of goods against cheque.
(3) Sale of goods Costing ₹ 50,000 for ₹ 60,000 on Credit.
(4) To sell a non-current asset at a slight loss.
(5) To borrow money on a promissory note (B/P).
(6) To give a promissory note to a Creditor.
(7) Payment of declared dividend.

[Ans. (1) Reduce, (2) No Change, (3) Improve, (4) Improve, (5) Reduce, (6) No Change, (7) Improve.]

Solution:-

The Current Ratio as given in the question is 2 : 1. In order to understand the question in a simple manner, It may be assumed that current assets are ₹ 2,00,000 and current liabilities are ₹ 1,00,000.

(1) Purchase of a Goods on Credit:-

Suppose, goods for ₹ 25,000 is purchased on credit, the revised current ratio will be:

$$\begin{gathered} = \frac{2,\mathrm{00,000} + \mathrm{25,000} \left(Inventory\right)}{1,\mathrm{00,000} + \mathrm{25,000} (Trade Payables)} \\ = \frac{2,\mathrm{25,000}}{1,\mathrm{25,000}} \\ = 1.8 : 1 \end{gathered}$$

Thus, Current Ratio is reduced.

(2) Purchase of goods against cash:-

Suppose, goods for ₹ 25,000 is purchased on cash, the revised current ratio will be:

$$\begin{gathered} = \frac{2,\mathrm{00,000} + \mathrm{25,000} \left(Inventory\right) – \mathrm{25,000} \left(Cash\right)}{1,\mathrm{00,000} } \\ = \frac{2,\mathrm{00,000}}{1,\mathrm{00,000}} \\ = 2 : 1 \end{gathered}$$

The Current Ratio will not changed.

(3) Sale of goods Costing ₹ 50,000 for ₹ 60,000 on Credit:-

$$\begin{gathered} = \frac{2,\mathrm{00,000} + \mathrm{60,000} \left(Debtors\right) – \mathrm{50,000} \left(Stock\right)}{1,\mathrm{00,000} } \\ = \frac{2,\mathrm{10,000}}{1,\mathrm{00,000}} \\ = 2.1 : 1 \end{gathered}$$

The Current Ratio will be improved

(4) To sell a non-current asset at a slight loss:-

Let’s suppose 55,000 of Machinery (Non-Current Assets) sold for ₹ 50,000.

As Machinery is not included either in current assets or current liabilities. This event would only raise the current assets via cash.

$$\begin{gathered} = \frac{2,\mathrm{00,000} + \mathrm{50,000} \left(Cash\right)}{1,\mathrm{00,000} } \\ = \frac{2,\mathrm{50,000}}{1,\mathrm{00,000}} \\ = 2.5 : 1 \end{gathered}$$

The Current Ratio will Improve.

(5) To borrow money on a promissory note (B/P):-

Let’s suppose ₹ 50,000 is borrowed against a Promissory note (B/P). It will increase cash (current assets) and Bills Payable (Current Liabilities) as follows

$$\begin{gathered} = \frac{2,\mathrm{00,000} + \mathrm{50,000} \left(Cash\right)}{1,\mathrm{00,000} + \mathrm{50,000} (Bill Payable) } \\ = \frac{2,\mathrm{50,000}}{1,\mathrm{50,000}} \\ = 1.67 : 1 \end{gathered}$$

The Current Ratio will Reduce.

(6) To give a promissory note to a Creditor:-

This transaction will results in decrease in Creditor (Current Liabilities) and increase in B/P (Current Liabilities).

Lets suppose ₹ 50,000 Promissory Note is given to the Creditor.

$$\begin{gathered} = \frac{2,\mathrm{00,000}}{1,\mathrm{00,000} + \mathrm{50,000} \left(Creditors\right) – \mathrm{50,000} (Promissory Note) } \\ = \frac{2,\mathrm{00,000}}{1,\mathrm{00,000}} \\ = 2 : 1 \end{gathered}$$

The Current Ratio will not Change

(7) Payment of declared dividend:-

Let’s suppose ₹ 50,000 declared dividend paid in cash.

It will result in reducing current liabilities (dividend) and reducing current assets (cash).

$$\begin{gathered} = \frac{2,\mathrm{00,000} – \mathrm{50,000} \left(cash\right)}{1,\mathrm{00,000} – \mathrm{50,000} \left(Dividend\right) } \\ = \frac{1,\mathrm{50,000}}{\mathrm{50,000}} \\ = 3 : 1 \end{gathered}$$

The Current Ratio will Improve.

Q. 3(B) The current ratio of a company is 2.5 : 1. State giving reasons which of the following suggestions would Improve, reduce and not change it:

(1) Payment to trade payables.
(2) Sell machinery against cheque.
(3) Sale of Inventory at loss on credit.
(4) Cash collected from trade receivables.
(5) B/R dishonoured.
(6) Issue of shares.
(7) Issue of shares against the purchase of a building.
(8) Redemption (Repayment) of Debentures maturing during the year.
(9) Purchase of Loose Tools against Cash.

[Ans. (i) Improve; (ii) Improve; (iii) Reduce; (iv) No Change; (v) No Change; (vi) Improve; (vii) No Change; (viii) Improve; (ix) Reduce.]

Solution:-

The Current Ratio as given in the question is 2.5 : 1. In order to understand the question in a simple manner, It may be assumed that current assets are ₹ 2,50,000 and current liabilities are ₹ 1,00,000.

(1) Payment to trade payables:-

Let’s suppose, ₹ 50,000 Trade payables

Payment to trade payables will decrease the current liabilities and decrease the current assets.

$$\begin{gathered} = \frac{2,\mathrm{50,000} – \mathrm{50,000} \left(cash\right)}{1,\mathrm{00,000} – \mathrm{50,000} (Trade Payables) } \\ = \frac{2,\mathrm{00,000}}{\mathrm{50,000}} \\ = 4 : 1 \end{gathered}$$

It will improve the Current Ratio.

(2) Sell machinery against cheque:-

Lets, suppose Machinery is sold for ₹ 50,000 for cheque.

It will increase the Cash at Bank (Current Assets) only. as machinery does not fall under neither in Current Assets nor in Current Liabilities.

$$\begin{gathered} = \frac{2,\mathrm{50,000} + \mathrm{50,000} (cash at Bank)}{1,\mathrm{00,000} } \\ = \frac{3,\mathrm{00,000}}{1,\mathrm{00,000}} \\ = 3 : 1 \end{gathered}$$

It will improve the Current Ratio.

(3) Sale of Inventory at loss on credit:-

Let’s suppose, Inventory of ₹ 50,000 is sold for ₹ 40,000 on credit.

It will decrease the current assets and increase the current liabilities. it will reduce the current ratio.

$$\begin{gathered} = \frac{2,\mathrm{50,000} – \mathrm{50,000} \left(Inventory\right)}{1,\mathrm{00,000} – \mathrm{40,000}} \\ = \frac{2,\mathrm{00,000}}{\mathrm{60,000}} \\ = 3.33 : 1 \end{gathered}$$

It will reduce the Current Ratio.

(4) Cash collected from Trade Receivables:-

Let’s suppose ₹ 50,000 is received from Trade Receivables.

It will reduce and increase the current assets with the same amoun. As current assets and current liabilities are intact. It will not change the Current Ratio.

$$\begin{gathered} = \frac{2,\mathrm{50,000} – \mathrm{50,000} (Trade Receivables) + \mathrm{50,000} \left(Cash\right)}{1,\mathrm{00,000}} \\ = \frac{2,\mathrm{50,000}}{1,\mathrm{00,000}} \\ = 2.5 : 1 \end{gathered}$$

(5) B/R dishonoured:-

Let’s suppose ₹ 50,000 Bills Receivables dishonoured.

It will increase debtors (Current Assets) and decrease Bills Receivables (Current Assets) with same amount. It will not change the Current Ratio.

$$\begin{gathered} = \frac{2,\mathrm{50,000} – \mathrm{50,000} (Trade Receivables) + \mathrm{50,000} \left(Debtors\right)}{1,\mathrm{00,000}} \\ = \frac{2,\mathrm{50,000}}{1,\mathrm{00,000}} \\ = 2.5 : 1 \end{gathered}$$

It will not change Current Ratio.

(6) Issue of Shares:-

Issue of shares will increase the cash (current assets). the current liabilities remain intact, it will increase the Current Ratio.

$$\begin{gathered} = \frac{2,\mathrm{50,000} + \mathrm{50,000} \left(Cash\right)}{1,\mathrm{00,000}} \\ = \frac{3,\mathrm{00,000}}{1,\mathrm{00,000}} \\ = 3 : 1 \end{gathered}$$

It will improve the Current Ratio.

(7) Issue of shares against the purchase of a building:-

Issue of shares increases Share Capital and purchase of building increases the Non-Current Assets.

Thus, Current Assets and Current Liabilities remain unchanged. It will not change the Current Ratio.

(8) Redemption (Repayment) of Debentures maturing during the year:-

Let’s suppose, ₹ 50,000 Debentures maturing during the year redeemed.

Debentures maturing during the year is considered as Current Liabilities.

It will reduce the current liabilities and Current assets (cash) with the same amount. It will improve the Current Ratio.

$$\begin{gathered} = \frac{2,\mathrm{50,000} – \mathrm{50,000} \left(Cash\right)}{1,\mathrm{00,000} – \mathrm{50,000} (Debentures maturing in Current year)} \\ = \frac{2,\mathrm{00,000}}{\mathrm{50,000}} \\ = 4 : 1 \end{gathered}$$

(9) Purchase of Loose Tools against Cash:-

Let’s Suppose, ₹ 50,000 Loose Tools are purchased.

Purchasing of the Loose Tools will result in the decrease in Cash (Current Assets), Loose Tools are not included in Current Assets for the calculation of Current Ratio. It will reduce the Current Ratio.

$$\begin{gathered} = \frac{2,\mathrm{50,000} + \mathrm{50,000} \left(Cash\right)}{1,\mathrm{00,000}} \\ = \frac{3,\mathrm{00,000}}{1,\mathrm{00,000}} \\ = 3 : 1 \end{gathered}$$

It will reduce the Current Ratio.