 Hello, and welcome to the session in which we would look at questions that illustrate the concept of current ratio and quick ratio. Ratios are important whether you are studying for the FAR exam as well as the audit, so it's very important to understand and know how to apply ratios. Now knowing the formula is a helpful, that's the starting point. They might ask you about what's the formula for the current ratio, what's the formula of the quick ratio? They might. That will be, it should be an easy question. But what they're going to ask you to do is to test you on how to apply those ratios. What happened to those ratios when an event takes place? And this is what you need to understand. It's not only memorizing the ratio which is important. You need to know what the ratios are. And it's important rather than memorizing them, understand them will help you even memorize them better because once you understand them, you can use logic to find out the answer. So we're going to go ahead and take a look at this question and solve it and show you how you would solve this questions on the CPA exam. Now before I start, if you are a CPA candidate, I strongly suggest you check out my website, farhatlectures.com. I don't replace your Becker, Roger, Gleam, Wiley or any other CPA course. That's not what I intend to do. I intend to be a useful addition. You can add me to your CPA studies and I can add 10 to 15 points to your CPA exam score by help you understand the concept better. I don't assume any knowledge. I teach you the material differently from your CPA review course, not better just differently. You might need that different perspective. I teach you the material as if you never saw it before in contrast to your CPA review course. Here's your risk. One month of subscription to check me out. Your potential gain is passing the exam. Are you willing to take that chance? And if not for anything, check out my website to find out how well or not well your university is doing on the CPA CPA exam. Whether you are a college student, I have various accounting courses as well. You can check me out. Please connect with me on LinkedIn and check out my LinkedIn recommendation to find out how other students use my system to pass the exam. Like this recording, share it, share it with others, connect with me on Instagram and Facebook. Now let's look at this question to find out what would happen to the ratios. Adam company, so this is the Adam company at the end of the year had a current ratio greater than one to one and a quick ratio less than one to one. Now the first thing is you want to know, do you know how to compute current ratio? Well, current ratio, you have to know this by heart equal to current assets. You have current assets and you divide current assets by current liabilities. In the quick ratio, in the quick ratio, you have to know how the quick ratio is computed as well. We have something called quick assets divide them by current liabilities. The first thing you want to notice about these two ratios is that that denominator is the same. Current liabilities is the denominator in both. Now what else do you need to know about current assets and current liabilities? In quick assets, you need to know its component. What is in current assets? Well, in current assets, you will find cash, you will find net receivable, you will find short-term investments, you will find, I'm going to change colors for a reason, you will find, let me find a better color here, you will find inventory, you will find supplies, you will find prepaid. Those typically are your current assets. So you're going to take those current assets and divide them by current liabilities and just know current liabilities are accounts payable, short-term debt, accrued liabilities and so forth. Now, you need to know what is composed of the quick asset and this is important. The quick assets are composed only of three assets and those are cash, let me put them in a different color again, those are cash, account receivable, net account receivable and short-term investments divided by the same thing, accounts payable, short-term debt, accrued liabilities. So at this point, you should have this memorized in your head, in other words, you know exactly what's inside each one of those. Not on the exam, you don't do this, you don't sit down and do this. The reason I'm doing this is because I want to explain to you what goes into current assets and current liabilities. You need to know this, like this is you need to know even before reading the question, it's like I already know how to compute current assets and current liabilities, I know what my current assets are. Just remember quick assets, the reason they are called quick asset because they can be quickly turned into cash. Cash itself is a quick asset, you can sell your account receivable and you could liquidate your short-term investments, short-term investments, okay, short-term investments. Now, let's focus on the problem itself. They're saying the current ratio is greater than one. Let's work with some numbers. If our current ratio, if CR equal to 10 divided by 5, simply put, I said we have 10 dollars of current assets, 5 dollars of current liabilities, the current ratio equal to 2. Now, what I'm going to do is this, I am going to pay off a dollar from my current assets and a dollar from my current liabilities and see what happened when I pay this dollar. So if I pay a dollar from my current assets, if I pay dollar in cash, I will have nine dollars in cash and four dollars in liabilities. So this is what I did. So if I take 9 divided by 4, it's going to give me 2.25. So what happened to my ratio, my current ratio went up. So simply put, now I'm going to be looking at my answers, decrease in the current ratio, wrong, decrease in the current ratio, wrong. I already eliminated two answers quickly. I'm already done with those two answers. So increase in current ratio, yes, I keep C and I keep the increase in current ratio. So notice, just by just understanding how current ratio is computed and taken one from each, one from the numerator, one from the denominator, I know I went down to 50-50. Now, all what I have to do now is test my quick ratio. Well, remember for the quick ratio, use a different color, you have to keep 5 the same because current liabilities is the same and the quick ratio, the quick ratio is less than 1. Therefore, I'm going to make up some numbers. My quick assets are 4 and I have to keep this as the same because current liabilities don't change in both formulas. So 4 divided by 5, this was my original ratio, 4 divided by 5 equal to 0.8. Now I'm going to take a dollar from the numerator and dollar from the numerator, reduce my cash with a dollar, reduce my accounts payable with a dollar. Now I'm going to say what happened if my quick ratio is 3 divided by 4. 3 divided by 4 equal to 0.75. So what happened to my quick ratio? My quick ratio decrease, my current ratio increase, therefore my answer is D. So once again, when you are looking at current ratio and quick ratios, you need to know the formula by heart. That's giving. Now, once you know the formula by heart, on the exam day, once they give you questions like this, test numbers, just like what I did. I said, okay, 10 divided by 5 equal to 2. This is my current ratio, reduce one from the numerator from, so pay off a dollar from cash, minus one cash, minus one accounts payable. So minus one cash, minus one accounts payable. My current ratio went up, I'm down to 50-50. Do the same thing for the quick ratio. Keep the denominator as the same 5, assume my quick assets are 4. My quick ratio is 0.8. If I remove one, if I remove a dollar from cash and a dollar from accounts payable, 3 to 4.75, and that's your answer. So these ratios are important for the CPA exam, whether it's the FAR or the audit. You have to understand the ratios very well because in analytics, analytical procedures, you need to know how to use the ratios. At the end of this recording, again, I'm going to invite you to visit my website, farhatlectures.com. This is what I do. I help you understand the material so you can do better on the CPA exam. You can understand these courses, these prep courses that you pay thousands of dollars for them better. I will increase your effectiveness in utilizing those courses. Think of my subscription as a vitamin pill that's going to help you pass the exam. Good luck, study hard, and most importantly, stay safe.