The correct answer is D, both ratios will decrease. The opening current ratio (current assets /current liabilities) is $1.8m/$1.0m = 1.8, and the opening acid test (current assets less stock/ current liabilities) is $1.3m/$1.0m = 1.3. Purchasing (say) $1.0m of inventory on short-term credit will decrease the current ratio to ($1.8m +$1m)/ ($1.0m+ $1.0m) = 1.4. The acid test would also decrease to $1.8m/ ($1.0m+ $1.0m) = 0.9.
Only 23% of candidates selected this alternative. The most frequently chosen alternative was C (41% of candidates). On this type of question if the answer is not immediately clear, candidates should substitute in some simple numbers to test out the effects of a transaction.
