Current ratio improvement is a widespread problem that is bothering every investor. Probably, it is the most often used liquid ratio analysis, and investors use the ratio to evaluate a firm’s ability to pay its short term debt obligation. According to Khadafi, Heikal & Ummah (2014), the current ratio is obtained by dividing current assets by currents liabilities. Improvement of the ratio whirls around the two above elements of the balance sheet. For instance, Ross’s lipstick company decision of reclassification of long-term investment to short term investment was tailored to alter current assets. Therefore, it is imperative to explore the impact of the intervention on the entity’s ability to honor its short-term financial obligation.
Reclassification of the long-term investments to short-term investments will improve the current ratio. Short-term financing constitutes current assets; thus, their change will have simultaneous effects on the current assets. That is, their escalations increase the total current assets. Because the ratio is obtained through the division of current assets by the current liabilities, an increase in the currents assets will improve the firm’s current ratio. A high current ratio implies a strong short-term financial position and efficiency in the operational cycle and management. Hence reclassification of long-term investments to short-term investment increases current ratio.
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However, in the above case, Ross’s lipstick company does not have a strong financial position as a result of the action. Reclassification of investments to reflect a high current ratio indicates inefficiency in both management and the operational cycle of the business. The company was affected by a change in consumer demand, and the establishment was no longer attracting customers; implying low sales and profitability. Reclassification of investment neither improved efficiency in management nor operation but only the quantity of the assets, thus the change had no effect on the total assets of the company in the balance sheet. Therefore, not adding values or changing the financial position of the firm.
The firm missed on profitable long-term investment opportunities and ignored long-term risks by prioritizing short-term earning expectations. Principally, short-term investments are characterized by low income and high risks. Also, investments have tax consequences. Furthermore, having a higher current ratio does not necessarily imply high financial position because it not sufficient. The ratio relies on the number of current assets at the expense of the quality of the assets ( Katsouras et al., 2015) . The management was interested in increasing assets and ignored the fact that it could have defaulters in the process. Hence did not have a robust financial position as a result of the action.
It was unethical for Ross’s lipstick company to revoke its decision on the reclassified long-term assets. Their action was inconsistent with what society considers right; they did not practice honesty, fairness, and equality, dignity, diversity, and individual rights.
First, they were self-centered that they took action to warrant their benefits at the expense of other parties. Initial, they reclassified to improve the current ratio, and later they revoke the decision because they were performing well in the market. It implies they are changing their systems thus violating consistency convention. According to the principle, it is vital to maintain accounting practices and procedures from period to period; it will help the users of financial information to easily evaluate the operations of the company over a given time (Yamey, 2014) . Also, the firm’s actions may have interfered with other firm's plans. After reclassification, other firms were willing to buy those investments and were compelled to change their budgets because of the action. Furthermore, they were not willing to disclose the information to the users of the data. Principally, the company canceled information regarding its poor performance: hence violating the accounting convention of materiality and full disclosure
References
Ferrell, O. C., & Fraedrich, J. (2015). Business ethics: Ethical decision making & cases . Nelson Education.
Khadafi, M., Heikal, M., & Ummah, A. (2014). Influence analysis of return on assets (ROA), return on equity (ROE), net profit margin (NPM), debt to equity ratio (DER), and current ratio (CR), against corporate profit growth in automotive in Indonesia Stock Exchange. International Journal of Academic Research in Business and Social Sciences , 4 (12).
Katsouras, I., Zhao, D., Spijkman, M. J., Li, M., Blom, P. W., De Leeuw, D. M., & Asadi, K. (2015). Controlling the on/off current ratio of ferroelectric field-effect transistors. Scientific reports , 5 , 12094.
Yamey, B. S. (2014). The Development of Company Accounting Conventions, by. In Evolution of Corporate Financial Reporting (RLE Accounting) (pp. 243-252). Routledge .
