FSA Question (Could have 2 possible answers) following, insurance, otherwise, possible, decrease

maxmeomeo

Assume U.S. GAAP applies unless otherwise noted.
Which of the following transactions will most likely result in a decrease in a company’s current ratio? The:
A. Recording of a warranty expense.
B. Recording of revenue before cash is received.
C. Payment of an insurance policy for the following year.

OmarAdnan

I think the correct choice should just be (A).
(A) Recording a warranty expense results in an increase in liabilities (warranty liability) and in assets (deferred tax asset). However, the increase in DTA only partially offsets the increase in liabilities since the DTA is just a percentage of the warranty liability based on the marginal tax rate. For example, given warranty expense of $100 and a marginal tax rate of say 40%, a warranty liability of $100 is recorded but a deferred tax asset of only $40 is recorded, meaning the current ratio decreased.
(B) Recognizing revenue before cash is received results in an increase in assets (accounts receivable) and an increase in equity (retained earnings). In this case the current ratio increases. Once the cash is collected, an asset (cash) increases and another asset (accounts receivable) decreases by the same amount. This has no effect on the current ratio since an asset increases and decreases by the same amount, so the overall net effect is an increase in the current ratio (because of the first transaction).
(C) Prepaying an insurance policy is a prepaid expense, which is an asset.

burning0spear

Stupid question I guess the assumption is the current ratio >1 otherwise you are correct.