TRUE/FALSE

1. Compensating balances reduce the amount of cash available to the borrower to meet obligations and they
decrease the effective interest rate for the borrower.

ANS: F

2. To qualify as a marketable security, the investment must be readily marketable and it must be the intent of
management to convert the investment to cash within the current operating cycle or a year, whichever is
longer.

ANS: T

3. In terms of liquidity, it is to management's advantage to show investments under investments instead of

marketable securities.

ANS: F

4. By reporting marketable equity securities under current assets, management picks up a liquidity
advantage.

ANS: T

5. The valuation problem from waiting to collect a receivable is ignored in the valuation of receivables and
notes that are classified as current assets.

ANS: T

6. Under the allowance method, the charge off of a specific account receivable does not influence the
income statement nor the net receivable on the balance sheet at the time of the charge off.

ANS: T

7. Using the direct write-off method, the bad debt expense is recorded when a specific customer's account is
determined to be noncollectible.

ANS: T

8. The direct write-off method frequently results in the bad debt expense being recognized in the year
subsequent to the sale, and thus results in a proper matching of expense with revenue.

ANS: F

9. When a company has receivables that are due beyond one year or accounting cycle from the balance sheet
date, and when it is the industry practice to include these receivables in current assets, they will be
included in current assets even though they do not technically meet the guidelines to qualify as current
assets.

ANS: T
10. The receivables of a company with installment receivables would normally be considered to be of higher
quality than the receivables of a company that did not have installment receivables.

ANS: F

11. If days' sales in receivables are materially longer than the credit terms, this indicates a collection problem.

ANS: T

12. The days' sales in receivables ratio gives an indication of the length of time that the receivables have been
outstanding at the end of the year. This indication can be misleading if sales are seasonal and/or the
company uses a natural business year.

ANS: T

13. Days' sales in receivables may be abnormally high at the end of the year if sales volume expanded
materially late in the year.

ANS: T

14. Days' sales in receivables may be abnormally high if a material amount of sales are on a cash basis.

ANS: F

15. When doing external analysis, many of the reasons why the days' sales in receivables is abnormally high
or low cannot be determined without access to internal information.

ANS: T

16. Inventory is particularly sensitive to changes in business activity. Therefore, management should keep
inventory at a minimum.

ANS: F

17. Because the cost of specific inventory items is not usually practical to determine, it is necessary for
management to select a cost flow assumption.

ANS: T

18. A firm that has been on lifo for many years may have some inventory costs that go back ten years or
more.

ANS: T

19. Under inflationary conditions, fifo generally results in a lower profit than does lifo, and this difference
can be substantial.

ANS: F

20. A low sales to working capital ratio tentatively indicates an unprofitable use of working capital.
 ANS: T

21. Working capital of a business is the excess of current assets over current liabilities.

ANS: T

22. The lifo inventory costing method usually results in working capital being overstated.

ANS: F

23. The lifo inventory costing method results in the acid-test ratio being overstated.

ANS: F

24. The cash ratio is usually a good indication of the liquidity of the firm.

ANS: F

25. Management should usually strive to keep the cash ratio high.

ANS: F

26. The ability of an entity to maintain its short-term, debt-paying ability is important to all users of financial
statements.

ANS: T

27. Even an entity on a very profitable course will find itself bankrupt if it fails to meets its obligations to
short-term creditors.

ANS: T

28. Current assets are assets that (1) are in the form of cash, (2) will be realized in cash, or (3) conserve the
use of cash within the operating cycle of a business or for one year, whichever is shorter.

ANS: F

29. The operating cycle is the time between the acquisition of inventory and the realization of cash from
selling the inventory.

ANS: T

30. In order to classify cash as a current asset, it must be free from any restrictions that would prevent its
deposit or use to pay creditors classified as long-term.

ANS: F

31. The use of the allowance for doubtful accounts results in the bad debt expense being charged to the period
of sale.

ANS: T
32. Customer concentration can be an important consideration in the quality of receivables.

ANS: T

33. A shortening of the credit terms is an indication that there will be more risk in the collection of future
receivables.

ANS: F

34. The company with the natural business year tends to overstate its accounts receivable turnover, thus
overstating its liquidity.

ANS: T

35. The election to use lifo for taxes governs the firm's financial reporting.

ANS: T

36. If the company closes the year when the activities are at a peak, the number of days' sales in inventory
would tend to be overstated and the liquidity would be overstated.

ANS: F

37. An approximation of the operating cycle can be determined from the receivable liquidity figures and the
inventory liquidity figures.

ANS: T

38. Working capital is considered to be more indicative of the short-term, debt-paying ability than is the
current ratio.

ANS: F

39. Liquidity problems with receivables and/or inventory means that the current ratio needs to be much
higher than when there are no such liquidity problems.

ANS: T

40. Significant weight is seldom given to the cash ratio unless the firm is in financial trouble.

ANS: T
B.

The Effect On
Acid
Working Current Test Cash
Transaction Capital Ratio Ratio Ratio

a. - - - -
b. none none none none
c. none + + -
d. + + + +
e. + + + +
f. none none none none
g. - - - -
h. none + + -
i. + + + +
j. + + + none
k. none + + -
l. none none none none
m. - - - none