Q13SE - Horngren'S Financial And Managerial Accounting

Question

Question: Silver Clothiers reported the following selected items at April 30, 2018 (last year’s—2017—amounts also given as needed):

Accounts Payable	\( 328,000	Accounts Receivable, net:
Cash	\) 573,720	April 30, 2018	\( 11,000
Merchandise Inventory:		April 30, 2017	\) 165,000
April 30, 2018	\( 250,000	Cost of Goods Sold	\) 1,200,000
April 30, 2017	\( 210,000	Short-term Investments	\) 148,000
Net Credit Sales Revenue	\( 3,212,000	Other Current Assets	\) 100,000
Long-term Assets	\( 350,000	Other Current Liabilities	\) 188,000
Long-term Liabilities	$ 130,000

Compute Silver’s (a) acid-test ratio, (b) accounts receivable turnover ratio, and (c) days’ sales in receivables for the year ending April 30, 2018. Evaluate each ratio value as strong or weak. Silver sells on terms of net 30. (Round days’ sales in receivables to a whole number.)

Step-by-Step Solution

Answer

Answer:

1. Acid-test ratio is 1.42, Strong
2. Accounts receivable ratio is 36.5, Strong
3. Day sales receivable ratio is 10 days, Strong

Step 1: Definition of acid-test ratio

The acid-test ratio measures the company’s ability to meet its short-term obligations with quick assets. It is also called as Quick Ratio.

Step 2: Calculation of acid-test ratio

$$\begin{gathered} \mathbf{Acid}\mathbf{-}\mathbf{Test} \mathbf{Ratio}\mathbf{=}\frac{\mathbf{Cash} \mathbf{Including} \mathbf{Cash} \mathbf{Equivalents}\mathbf{+} \mathbf{Short}\mathbf{-}\mathbf{term} \mathbf{Investments}\mathbf{+}\mathbf{Net} \mathbf{Current} \mathbf{Receivables}}{\mathbf{AccountsPayable}\mathbf{+}\mathbf{OtherCurrentLiabilities}} \\ \mathbf{=}\frac{\mathbf{\$}\mathbf{573}\mathbf{,}\mathbf{720}\mathbf{+}\mathbf{\$}\mathbf{148}\mathbf{,}\mathbf{000}\mathbf{+}\mathbf{\$}\mathbf{11}\mathbf{,}\mathbf{000}}{\mathbf{\$}\mathbf{328}\mathbf{,}\mathbf{000}\mathbf{+}\mathbf{\$}\mathbf{188}\mathbf{,}\mathbf{000}} \\ \mathbf{=}\mathbf{1}\mathbf{.}\mathbf{42} \end{gathered}$$

Step 3: Calculation of accounts receivable turnover ratio

$$\begin{gathered} \mathbf{Accounts} \mathbf{Receivable} \mathbf{Turnover} \mathbf{Ratio}\mathbf{=}\frac{\mathbf{Net} \mathbf{Credit} \mathbf{Sales}}{\mathbf{Average} \mathbf{Net} \mathbf{Accounts} \mathbf{Receivables}} \\ \mathbf{=}\frac{\mathbf{\$}\mathbf{3}\mathbf{,}\mathbf{212}\mathbf{,}\mathbf{000}}{\left(\frac{\mathbf{\$}\mathbf{11}\mathbf{,}\mathbf{000}\mathbf{+}\mathbf{\$}\mathbf{165}\mathbf{,}\mathbf{000}}{\mathbf{2}}\right)} \\ \mathbf{=}\mathbf{36}\mathbf{.}\mathbf{5} \mathbf{times} \end{gathered}$$

Step 4: Calculation of day’s sales in receivables ratio

$$\begin{gathered} \mathbf{Day}\mathbf{\text{'}}\mathbf{s} \mathbf{Sales} \mathbf{Receivables}\mathbf{=}\frac{\mathbf{365} \mathbf{Days}}{\mathbf{Accounts} \mathbf{Receivable} \mathbf{Turnover} \mathbf{Ratio}} \\ \mathbf{=}\frac{\mathbf{365}}{\mathbf{36}\mathbf{.}\mathbf{5}} \\ \mathbf{=}\mathbf{10} \mathbf{Days} \end{gathered}$$

Step 5: Analysis of ratio

1. Acid-test ratio is strong, as it exceeds 1, which is good.  
2. Accounts receivable turnover ratio is strong. 
3. Day’s sales in receivables is strong, as business is able to collect cash in 10 days which is less than 30 days credit terms.