Question

Quick Ratio of Z Ltd. is 1 : 1. State, with reason, which of the following transactions would (i) Increase (ii) Decrease or (iii) Not change the ratio:

1. Creditors of ₹ 10,000 were paid on due date;
2. Debentures of ₹ 50,000 were converted into equity shares.

Answer 1

(a) Creditors of ₹ 10,000 were paid on the due date

Effect: No Change

Reason: This transaction reduces both Quick Assets (Cash) and Current Liabilities (Creditors) by the same amount. Since the initial ratio is 1 : 1, subtracting equal amounts from both the numerator and the denominator leaves the ratio unchanged.

Example: Let Quick Assets = ₹ 1,00,00, Current Liabilities = ₹ 1,00,000
\[\text{New Ratio} = \frac{1,00,000 - 10,000}{1,00,000 - 10,000} = \frac{90,000}{90,000} = 1 : 1\] 

(b) Debentures of ₹ 50,000 were converted into equity shares

Effect: Increase

Reason: Debentures due for conversion are treated as Current Liabilities. Their conversion reduces Current Liabilities while Quick Assets remain unchanged. A decrease in the denominator increases the ratio.

Example: Let Quick Assets = ₹1,00,00, Current Liabilities = ₹1,00,000
$$\text{New Ratio} = \frac{1,00,000}{1,00,000 - 50,000} = \frac{1,00,000}{50,000} = 2 : 1$$