Question

Presented below is information available for Morton Company.

Current Assets
Cash $ 5,000
Short-term investments 72,000
Accounts receivable 65,000
Inventory 160,000
Prepaid expenses 40,000
Total current assets $ 342,000

Total current liabilities are $160,000. The acid-test ratio for Morton is
A) 0.48 to 1.
B) 0.89 to 1.
C) 1.89 to 1.
D) 2.14 to 1.

Answer 1

To calculate the acid-test ratio for Morton Company, sum up its most liquid assets—cash, short-term investments, and accounts receivable—and divide by total current liabilities. The calculation shows an acid-test ratio of 0.89 to 1, which means Morton has $0.89 in liquid assets for every dollar of liability.

Step-by-step explanation:

The acid-test ratio, also known as the quick ratio, is a financial metric used to assess a company's ability to meet its short-term obligations with its most liquid assets. To calculate the acid-test ratio for Morton Company, we take the sum of cash, short-term investments, and accounts receivable (which are considered liquid assets) and divide that by the total current liabilities.

The formula for the acid-test ratio is as follows:

Acid-test Ratio = (Cash + Short-term Investments + Accounts Receivable) / Total Current Liabilities

Using the information from Morton Company:

Acid-test Ratio = ($5,000 + $72,000 + $65,000) / $160,000

Acid-test Ratio = $142,000 / $160,000

Acid-test Ratio = 0.89 to 1

This calculation shows that for every dollar of current liabilities, Morton Company has $0.89 in liquid assets, indicating the acid-test ratio for Morton is B) 0.89 to 1.