Q1DC - Horngren'S Financial And Managerial Accounting

Question

Lance Berkman is the controller of Saturn, a dance club whose year-end is December 31. Berkman prepares checks for suppliers in December, makes the proper journal entries, and posts them to the appropriate accounts in that month. However, he holds on to the checks and mails them to the suppliers in January.

Requirements

1. What financial ratio(s) is(are) most affected by the action to hold onto the checks until January?

2. What is Berkman’s purpose in undertaking this activity?

Step-by-Step Solution

Answer

1. Financial ratio affected are current ratio, quick ratio and cash ratio.
2. Purpose of Berkman’s this activity is to show that liquidity of firm is good.

Step 1: Financial ratio get affected:

Financial ratios like current ratio, quick ratio, and cash ratio get affected because, in calculating all these ratios, accounts payable and cash are involved as the value of these changes’ ratio gets impacted.

Step 2: Berkmans Purpose

Berkman’s purpose is to show that firm has good short-term liquidity by lowering the book value of the liability and keeping assets unaffected. Berkman's activity of posting checks amount to respective account brings down the liability value, but payment is not made cash remain unaffected, which improve the liquidity ratio.