ACID TEST RATIO FORMULA

Acid Test Ratio, a type of liquidity ratio, may be defined as the relationship between Acid Test or Acid Test assets and current liabilities. An asset is said to be Acid Test if can be converted into cash within a short period without loss of value. The Acid Test ratio is also known as liquid ratio or quick ratio. This ratio is the more rigorous test of liquidity that the current ratio. The Acid Test ratio interpretation is made with reference to current assets excluding prepaid expenses and inventories i.e. Acid Test assets and current liabilities. The Acid Test ratio formula is as follows:

Acid Test Ratio= Acid Test Assets/ Current Liabilities.

EXAMPLE: Suppose the Acid Test assets of a concern as Rs. 2,50,000 and current liabilities of the concern are Rs. 1,00,000. The current ratio will be calculated as follows:

Acid Test ratio= Acid Test Assets/ Current Liabilities

Acid Test ratio= 2,50,000/1,00,000

Acid Test Ratio= 2.5:1.

ACID TEST ASSETS: Acid Test assets are the assets that can be easily converted into cash. These assets include the following assets:

• Cash in hand
• Cash at bank
• Bills receivables
• Sundry debtors
• Marketable securities
• Temporary investments

Assets not included in Acid Test assets are:

• Prepaid expenses
• Inventories.

These can be calculated as:

Acid Test Assets= Current Assets- Prepaid expenses- Inventories

CURRENT LIABILITIES: Current liabilities are the liabilities payable within 12 months from the date of balance sheet or within the period of operating cycle. Current liabilities include the following liabilities:

• Short term borrowings
• Trade payables i.e. creditors and bills payable
• Short term provisions
• Outstanding expenses
• Incomes received in advance, etc.

ACID TEST RATIO INTERPRETATION

A high Acid Test ratio is an indication that the firm is Acid Test and has the ability to meet its current or Acid Test liabilities. The high Acid Test ratio is bad when the firm is having slow-paying debtors.

On the other hand, a low Acid Test ratio represents that the firm’s liquidity position is not good. The low Acid Test ratio may be considered satisfactory if it has fast moving inventories.

IDEAL ACID TEST RATIO

The ideal Acid Test ratio is 1:1. It means the current assets should be equal to the current liabilities only then the firm will be able to meet its short term obligations. Although the Acid Test ratio is more rigorous test of liquidity than current ratio, yet it should be used cautiously and rule 1:1 should not be used blindly. A Acid Test ratio of 1:1 does not necessarily mean satisfactory liquidity position if all the debtors cannot be realized and cash is needed immediately to meet the current obligations of the firm.

SIGNIFICANCE OF ACID TEST RATIO

The Acid Test ratio is very useful in measuring the liquidity position of a firm. It measures the firm’s capacity to pay off current obligations immediately and is a more rigorous test of liquidity than the current ratio. It is used as a complementary ratio to the current ratio.

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Difference between cost accounting and financial accounting	Financial accounting, cost accounting and management accounting	Difference between hire purchase and instalment system	Financial ratio analysis
Difference between transaction and event	Transactions	Users of Accounting	Ratio analysis
Limitation of Accounting	Capital Expenditure	Instalment System	Difference between consignment and sale
Book Keeping	Revenue Expenditure	Reserves Accounting	Abnormal loss vs normal loss in consignment
Accountancy	Difference between capital and revenue expenditure	Provisions	Treatment of loss on consignment
Accounting as science or an art	Accounting Equation	Single entry system	Accounting treatment of consignment
Book Keeping vs accounting	Deferred Revenue Expenditure	Difference between statement of affairs and balance sheet	Joint venture vs consignment
Book keeping vs accountancy	Capital receipt	IFRS	Departmental Accounting
Accounting vs accountancy	Revenue receipt	Balance Sheet	Methods of departmental accounting
Basis of Accounting	Difference between capital and revenue receipt	Profit and loss Account	Allocation of expenses in departmental accounting
Branches of accounting	Difference between accounting concepts and conventions	Trading Account	Inter-departmental transfers
Cash and mercantile system of accounting	Accounting Standards	Voyage Account	Different types of branches
Accounting Principles	Objectives of Accounting	Accounting for Incomplete Voyage	Departmental vs Branch accounting
Golden ru les of accounting	Process of Accounting	Joint venture	Methods of branch accounting
Double entry system of book keeping	Scope of Accounting	Joint Venture Vs Partnership	Incorporation of branch trial balance
Double entry vs Single entry system	Accounting Concepts vs Accounting conventions	Methods of recording transactions in Joint Venture	Garner VS Murray Rule
History of Accounting	Difference between provisions and reserves	Consignment