WGU Accounting-for-Decision-Makers Exam - Topic 1 Question 6 Discussion

The correct answer is B. The company has 1.5% more total liabilities than total assets. The debt ratio is calculated as:

Debt ratio = Total liabilities / Total assets

If the debt ratio is 101.5%, or 1.015, that means total liabilities are 101.5% of total assets. In other words, liabilities are slightly greater than assets. Specifically, the company has 1.5% more liabilities than assets.

This is an important financial warning sign because it suggests the company may have negative equity. Since the accounting equation is:

Assets = Liabilities + Owners' equity

if liabilities exceed assets, then owners' equity must be negative. That can indicate financial distress, accumulated losses, or a highly leveraged position.

Option A is incorrect because the debt ratio does not compare liabilities to sales. Option C is incorrect because it does not compare liabilities to net income. Option D is incorrect because the debt ratio uses total liabilities and total assets, not current liabilities and current assets. Therefore, the only correct interpretation of a 101.5% debt ratio is that total liabilities exceed total assets by 1.5%, making Option B correct.