Principle of Account Question


Valencia Couture is going into production with a new line of ladies’ evening wear and wish to purchase large quantities of raw materials from your company. You have been asked to investigate the financial soundness and the debt-paying abilities of the company. After checking around, you discover that Valencia Couture Inc., in their most recent fiscal year, had a current ratio of 2.8, compared with 1.9 in the prior year. Their income this year was half that of the previous year.


a.Why would the increase in the current ratio be unexpected?

b.Identify two possible circumstances not involving borrowing or the issuance of capital stock that could account for the increase in the current ratio.

1 Answer

  • 1 decade ago
    Favorite Answer

    For a., the reduction of income represents reduced purchases and creditors. If income and expenses reduced at the same pace, current ration should not be increasing at such a high level.

    For b., the possible reasons can be:

    1. The significant increase in long term investment or fixed assets, therefore drain up the cash or liquid resources of the Company; and

    2. The potential risk of litigation being accounted for in the liabilities.

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