FAR · Financial reporting · 13 practice questions
Current Ratio After Paying Accounts Payable: The 1.0 Rule
When cash pays accounts payable, a starting current ratio above 1.0 rises, one below 1.0 falls, and 1.0 stays unchanged. Compare the same payment with only the starting assets or payment date changed.
Try one first
Hint
Think about what happens when the same dollar amount is removed from both current assets and current liabilities.
Answer A. Paying a current liability with cash reduces current assets and current liabilities by the same dollar amount. If the initial current ratio is greater than 1.0 (current assets > current liabilities), subtracting the same amount from numerator and denominator increases the ratio; if it is less than 1.0 the ratio decreases; if it equals 1.0 the ratio remains unchanged. Thus the starting current ratio relative to 1.0 governs the direction of the change.
Why not B: This distractor plays on thinking about the original transaction, but once an obligation is classified as a current liability, paying it with cash reduces current assets and current liabilities equally regardless of whether the payable arose from inventory or operating expenses.
Why not C: Large payments change the magnitude of the ratio but not the direction rule; the relevant comparison is current assets versus current liabilities, not materiality relative to total assets. Direction depends on the starting current ratio, not on total-asset materiality.
Why not D: Timing near year-end may affect reporting periods, but the immediate mathematical effect of paying a current liability with cash is determined by the prepayment current ratio; the calendar date does not change the direction of the ratio change.
Same scenario, one fact changes
Base case
On December 31, Year 1, before a payment, Pine Co. has current assets of $240,000 and current liabilities of $120,000. Pine pays $30,000 of existing accounts payable with cash that day. Assume no discounts, gains, losses, or other changes. Determine its year-end current ratio and working capital.
Answer: The current ratio increases from 2.00 to 2.33. Working capital remains $120,000.
After payment, current assets are $210,000 and current liabilities are $90,000. The ratio is $210,000 ÷ $90,000 = 2.33. Working capital is $210,000 minus $90,000 = $120,000.
Before you open each one, predict the answer.
Change 1Starting current assets are $90,000 instead of $240,000.
Answer: The current ratio decreases from 0.75 to 0.67. Working capital remains negative $30,000.
The starting ratio is below 1.0. After payment, $60,000 ÷ $90,000 = 0.67. Working capital remains $60,000 minus $90,000 = negative $30,000.
Change 2Starting current assets are $120,000 instead of $240,000.
Answer: The current ratio remains 1.00. Working capital remains $0.
After payment, current assets and current liabilities both equal $90,000. Equal balances keep the ratio at 1.00 and working capital at $0.
Change 3The payment occurs on January 2, Year 2, instead of December 31, Year 1.
Answer: The reported December 31 current ratio remains 2.00. Working capital remains $120,000.
The payment occurs after the balance sheet date. December 31 balances remain $240,000 and $120,000, so the reported ratio stays 2.00.
Key points
- Remember: Equal dollar decreases preserve a difference, not a ratio, unless that ratio starts at 1.0.
- Recalculate: current ratio = remaining current assets ÷ remaining current liabilities.
- Use the direction rule when the payment is less than both current assets and current liabilities.
- A payment after year-end does not change the current ratio reported at year-end.
How the exam traps you
- Cash decreases, so the current ratio must decrease. Reduce accounts payable too. The starting ratio determines the direction.
- Equal dollar decreases leave the current ratio unchanged. Equal decreases preserve working capital. They preserve the current ratio only when it starts at 1.0.
- Paying accounts payable always improves the current ratio. Check the starting ratio. Below 1.0, the payment lowers the ratio.
Now the same facts as questions
Each question changes one fact from the one before. Watch which change flips the answer.
Question 1
Answer C. Correct. $210,000 ÷ $90,000 = 2.33; $210,000 minus $90,000 = $120,000.
Why not A: Incorrect. $210,000 ÷ $120,000 ignores the reduction in accounts payable.
Why not B: Incorrect. Equal dollar decreases do not preserve a ratio that starts above 1.0.
Why not D: Incorrect. Both balances fall by $30,000, so working capital stays $120,000.
Question 2
Answer B. Correct. $60,000 ÷ $90,000 = 0.67; $60,000 minus $90,000 = negative $30,000.
Why not A: Incorrect. This is the starting ratio; equal dollar decreases do not preserve a ratio below 1.0.
Why not C: Incorrect. A payment cannot eliminate the existing $30,000 gap between current assets and current liabilities.
Why not D: Incorrect. Working capital stays negative $30,000 because both balances decrease equally.
Question 3
Answer D. Correct. Both ending balances are $90,000, producing a 1.00 ratio and $0 working capital.
Why not A: Incorrect. Equal decreases leave the initial $0 working capital unchanged.
Why not B: Incorrect. $120,000 ÷ $90,000 reduces liabilities but ignores the cash payment.
Why not C: Incorrect. $90,000 ÷ $120,000 reduces assets but ignores the payable reduction.
Question 4
Answer B. Correct. December 31 balances remain $240,000 and $120,000; the later payment does not change them.
Why not A: Incorrect. This is the ratio after the January payment, not the December 31 ratio.
Why not C: Incorrect. This reduces only cash and also applies a January transaction to December balances.
Why not D: Incorrect. December 31 working capital remains $240,000 minus $120,000 = $120,000.
Question 2
| Financial Item | Amount |
|---|---|
| Cash (includes $35,000 legally restricted for plant expansion) | $140,000 |
| Trading securities | $60,000 |
| Net trade receivables | $215,000 |
| Inventory | $290,000 |
| Prepaids | $20,000 |
| Accounts payable | $180,000 |
| Accrued liabilities | $95,000 |
| Current maturities of long-term debt | $90,000 |
| Customer advances | $40,000 |
Hint
Track each choice by asking whether it changes total quick assets, total current liabilities, or only shifts amounts within the same category.
Answer A. Before any transaction, quick assets are $380,000 (( $140,000 − $35,000 ) + $60,000 + $215,000) and current liabilities are $405,000, so the quick ratio is about 0.94. Selling $50,000 of inventory for $50,000 cash converts a non-quick asset into a quick asset without changing current liabilities, increasing quick assets to $430,000 while liabilities remain $405,000. The quick ratio becomes about 1.06, so Harbor would be in compliance.
Why not B: Purchasing inventory increases a non-quick asset and increases accounts payable. Quick assets remain unchanged while current liabilities rise by $50,000, which worsens the quick ratio and cannot bring Harbor into compliance.
Why not C: Paying accounts payable reduces both quick assets (cash) and current liabilities by the same amount. When the initial quick ratio is below 1.00, reducing numerator and denominator by the same amount generally lowers the ratio (here about 330,000/355,000 ≈ 0.93), so Harbor remains noncompliant.
Why not D: Collecting receivables shifts $50,000 from one quick-asset category (receivables) to another (cash) but does not change total quick assets or current liabilities, so the quick ratio remains about 0.94 and Harbor stays out of compliance.
Question 3
Hint
Start by identifying which choices change current assets, current liabilities, or both. Then consider what happens when equal amounts are added to both parts of a ratio that is already greater than 1.0.
Answer D. The purchase increases both current assets (inventory) and current liabilities (accounts payable) by $40,000. When the current ratio is greater than 1.0, adding the same amount to the numerator and denominator reduces the ratio, here it moves from 300,000/150,000 = 2.00 to 340,000/190,000 ≈ 1.79. Therefore the current ratio decreases.
Why not A: Tempting because collections increase cash, but collecting receivables simply converts one current asset (AR) to another (cash), so total current assets and current liabilities are unchanged and the current ratio stays at 2.00.
Why not B: Issuing stock increases cash (a current asset) without changing current liabilities, so the numerator increases while the denominator stays the same and the current ratio increases (340,000/150,000 ≈ 2.27), not decreases.
Why not C: This seems like reduced liquidity, but paying accounts payable decreases both current assets (cash) and current liabilities by $40,000; with an initial ratio above 1.0 that actually increases the current ratio (260,000/110,000 ≈ 2.36), so it does not decrease.
Question 4
Hint
Compute the metric before and after the payment. Remember that working capital is a dollar amount, while the current ratio is a relationship.
Answer A. Before payment, the current ratio is 280,000 / 200,000 = 1.40. After paying the accrued liability, current assets become $240,000 and current liabilities become $160,000, so the current ratio becomes 240,000 / 160,000 = 1.50. Working capital remains $80,000 because both current assets and current liabilities decrease by the same $40,000.
Why not B: This is tempting because candidates often assume that using cash automatically hurts liquidity. However, when both current assets and current liabilities decrease by the same amount and the initial current ratio is above 1.0, the ratio actually increases. The working capital part is correct, but the ratio direction is wrong.
Why not C: This reflects the shortcut that paying cash only reduces assets. In this case the liability is also removed, so the current ratio does change and working capital (current assets minus current liabilities) does not decrease because both sides fall by the same amount.
Why not D: The first half is correct, paying a current liability with cash can improve the current ratio when it starts above 1.0, but working capital is unchanged since current assets and current liabilities both decline by $40,000, leaving the dollar difference the same.
Question 5
Hint
Recalculate the current ratio after updating both current assets and current liabilities for the December 31 payment.
Answer C. The cash payment reduces both current assets and current liabilities by $40,000. After the payment, current assets are $200,000 and current liabilities are $120,000, so the current ratio is $200,000 ÷ $120,000 = 1.67 to 1; because the payment occurs on December 31 before finalizing statements, it affects the year-end ratio immediately.
Why not A: This result would occur if a candidate reduces cash by $40,000 but forgets to reduce accounts payable, leaving liabilities at $160,000 (200,000 ÷ 160,000 = 1.25). The payment actually reduces both current assets and current liabilities.
Why not B: This is the initial current ratio (240,000 ÷ 160,000 = 1.50) and is tempting if a candidate assumes paying one current item with another leaves the ratio unchanged. Even though both sides decrease by the same dollar amount, the ratio generally changes unless the numerator and denominator are equal.
Why not D: This would result from decreasing liabilities by $40,000 but failing to decrease cash (240,000 ÷ 120,000 = 2.00). A cash payment lowers current assets as well as current liabilities, so that answer is incorrect.
Question 6
Hint
Focus only on the current ratio formula and recalculate it after the cash payment reduces both current assets and current liabilities.
Answer D. The current ratio equals current assets divided by current liabilities. Before the payment, the ratio is $240,000 / $160,000 = 1.50. After paying $40,000 of accounts payable with cash, current assets become $200,000 and current liabilities become $120,000, so the ratio is $200,000 / $120,000 = 1.67. Because the ratio started above 1.0, reducing both current assets and current liabilities by the same amount increases the current ratio.
Why not A: This distractor confuses the current ratio with broader solvency measures. The current ratio uses only current assets and current liabilities, and the information given is sufficient to compute before-and-after ratios.
Why not B: This distractor arises if a candidate focuses only on the drop in cash and assumes liquidity worsens; that would give $200,000 / $160,000 = 1.25 only if current liabilities stayed the same. In this transaction accounts payable also decreases by $40,000, so the correct recalculation yields 1.67.
Why not C: A common shortcut mistake is to assume a ratio is unchanged when numerator and denominator fall by the same dollar amount. Ratios do not generally remain the same; here 240,000/160,000 = 1.50 while 200,000/120,000 = 1.67.
Question 7
Hint
Focus on what happens to total current assets and total current liabilities, not just whether cash goes up or down.
Answer D. Because Lane's current ratio is greater than 1.0, reducing both current assets and current liabilities by the same amount will increase the ratio. Paying accounts payable with cash reduces cash (a current asset) and accounts payable (a current liability) by the same amount, which raises the current ratio. For example, CA = 180 and CL = 100; paying 20 changes the ratio from 180/100 = 1.8 to 160/80 = 2.0.
Why not A: Tempting if focusing only on cash outflow, but prepaid insurance is also a current asset; cash decreases while prepaid insurance increases by the same amount, leaving total current assets and current liabilities unchanged, so the current ratio does not change.
Why not B: Tempting because collecting receivables increases cash (improving liquidity), but accounts receivable and cash are both current assets, so total current assets (and current liabilities) are unchanged and the current ratio stays the same.
Why not C: Tempting because inventory is a current asset, but buying on short-term credit increases current assets (inventory) and current liabilities (payables) by the same amount; when the current ratio is above 1.0, adding equal amounts to numerator and denominator lowers the ratio.
Question 8
Hint
Focus on which transaction changes current liabilities without reducing current assets.
Answer B. Refinancing converts the $20,000 short-term note into long-term debt, removing it from current liabilities while leaving current assets at $180,000. Current liabilities fall to $80,000, so the current ratio becomes 180,000 / 80,000 = 2.25. That is higher than the ratios produced by the other transactions.
Why not A: This is tempting because converting receivables to cash feels like improved liquidity, but total current assets and current liabilities do not change. The current ratio remains 180,000 / 100,000 = 1.80.
Why not C: Buying inventory on short-term credit increases current assets and current liabilities by the same amount (200,000 and 120,000), producing a ratio of 200,000 / 120,000 ≈ 1.67. Increasing both numerator and denominator can lower the ratio.
Why not D: Paying accounts payable reduces both current assets and current liabilities to 160,000 and 80,000, respectively, giving a ratio of 160,000 / 80,000 = 2.00. That improves the ratio versus the starting point, but not as much as refinancing the short-term note.
Question 9
Hint
Start with the current ratio before the transaction, then ask whether the transaction changes only the mix of current assets or changes both current assets and current liabilities.
Answer B. Blue's current ratio starts at 1.8 (180,000 / 100,000). Paying $30,000 of accounts payable with cash reduces current assets and current liabilities to $150,000 and $70,000, respectively, raising the ratio to about 2.14. Because the starting ratio is above 1.0, reducing both numerator and denominator by the same amount increases the current ratio.
Why not A: Collecting receivables simply converts one current asset (accounts receivable) into another (cash); total current assets and current liabilities remain unchanged, so the current ratio does not change.
Why not C: Buying inventory on account increases current assets and current liabilities by the same amount. With the initial ratio above 1.0, increasing both numerator and denominator by the same amount lowers the current ratio.
Why not D: Borrowing cash increases current assets and also increases current liabilities (the 30-day note). Like (B), that increases both sides by the same amount and will lower the current ratio when the starting ratio is greater than 1.0.
Common questions
Why does paying accounts payable increase the current ratio?
It increases the ratio only when the starting ratio exceeds 1.0. Both balances fall equally, but the payment removes a larger percentage of current liabilities than of current assets.
What happens when the current ratio is below 1.0?
Paying accounts payable with cash decreases it further. Current assets are smaller than current liabilities, so the equal dollar payment removes a larger percentage of current assets.
Does paying accounts payable change working capital?
No. Working capital equals current assets minus current liabilities, and subtracting the same payment from both leaves that difference unchanged.
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