Conversion of Short-Term Note Payable to Long-Term Note Payable

D

This transaction reduces current liabilities, but does not change current assets and, therefore, increases working capital and increases the current ratio.

The correct answer to the question is C. decrease working capital and the current ratio.

When a company converts a short-term note payable into a long-term note payable, it means that the company is extending the maturity date of the debt obligation from the short term (usually within a year) to the long term (typically beyond a year). This conversion has implications for the company's working capital and current ratio, which are measures of the company's short-term financial health.

Working capital is a measure of a company's ability to meet its short-term obligations and is calculated as current assets minus current liabilities. By converting a short-term note payable into a long-term note payable, the company effectively reduces its current liabilities because the debt is no longer due within the next year. As a result, working capital decreases since the reduction in current liabilities outweighs any potential changes in current assets. Hence, option E (decrease only working capital) can be ruled out.

The current ratio is another measure of a company's short-term liquidity and is calculated by dividing current assets by current liabilities. Converting a short-term note payable into a long-term note payable reduces the company's current liabilities but does not have a direct impact on current assets. Since both the numerator and denominator of the current ratio decrease, the ratio itself decreases as well. Therefore, option C (decrease working capital and the current ratio) is the correct answer.

Options B, D, and E are incorrect:

• Option B (increase working capital) is incorrect because the conversion of the short-term note into a long-term note reduces current liabilities and thus decreases working capital.
• Option D (increase both working capital and the current ratio) is incorrect because, as explained earlier, the conversion reduces both working capital and the current ratio.
• Option A (none of these answers) is incorrect because option C provides the correct explanation for the impact of the transaction.

To summarize, when a company converts a short-term note payable into a long-term note payable, it reduces its current liabilities, resulting in a decrease in working capital and the current ratio.