Question

Assertion (A): If Current Ratio is 2 : 1 and Liquid Ratio is 1.2 : 1, sale of goods costing ₹ 2,00,000 for ₹ 1,80,000 on credit will result in decline in both the current as well as liquid ratio.

Reason (R): Current Ratio will decline because one Current Asset (debtors) has increased by ₹ 1,80,000 whereas another Current Asset (inventory) has decreased by ₹ 2,00,000. Liquid Ratio will improve because Liquid Assets have increased whereas Current Liabilities remain unchanged.

In the context of the above two statements, which of the following is correct?

Options

• Both (A) and (R) are true, but (R) is not the correct explanation of (A).

• Both (A) and (R) are true and (R) is the correct explanation of (A).

• Both (A) and (R) are false.

• (A) is false, but (R) is true.

Answer 1

(A) is false, but (R) is true.

Explanation:

When goods worth ₹ 2,00,000 are sold for ₹ 1,80,000 on credit, inventory decreases by ₹ 2,00,000 and debtors increase by ₹ 1,80,000. This results in a ₹ 20,000 loss in total current assets and a decline in the current ratio. However, because inventory is not included in liquid assets, only debtors increase while current liabilities remain unchanged, resulting in an improved liquid ratio. As a result, the assertion is false, but the reason is true.