ACCA Applied Skills · Financial Reporting · Limitations of financial statements
Alder plc and Birch plc operate in the same industry and have identical revenue of $10 million and identical operating profit of $2 million. Alder holds its freehold properties at depreciated historical cost, bought 25 years ago. Birch revalued its freehold properties to current market value this year. Which of the following is the most likely effect when comparing return on capital employed (ROCE) for the two companies?
Alder's ROCE will look higher because its properties are carried at old depreciated cost, giving lower capital employed. Birch's revaluation increases its asset base while profit stays the same. Different measurement bases therefore distort the comparison, even though both companies earn identical profit and revenue.
- AAlder's ROCE will appear higher than Birch's because its capital employed is lower, so the comparison is distortedCorrect
- BAlder's ROCE will appear lower than Birch's because its older assets generate lower profits
- CBirch's ROCE will appear higher than Alder's because revaluation increases operating profit
- DThe ROCE figures are directly comparable because the operating profit and revenue are identical
Explanation
Revaluing property raises Birch's carrying amount and therefore its capital employed, while operating profit is unchanged (apart from any extra depreciation, which would reduce it further). Alder's older cost-based assets give a lower capital employed, so its ROCE looks higher even though performance is identical. Option D is wrong because different measurement bases make the ratios non-comparable.
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