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ACCA Applied Knowledge · Financial Accounting · Stakeholders' needs

Carlton Co's financial statements for the year show revenue of $800,000, profit from operations of $120,000, finance costs of $20,000 and total equity plus non-current liabilities (capital employed) of $1,000,000. A lender wants to assess return on capital employed, defined as profit before interest and tax divided by capital employed. There is no other income. What ROCE should the lender calculate, and which user need does this ratio mainly address?

ROCE is 12%, being profit before interest and tax of $120,000 divided by capital employed of $1,000,000. It helps lenders and investors judge how effectively the entity generates returns on the funds provided. Deducting finance costs would wrongly give 10%.

  1. A10%, addressing the lender's need to assess profit after finance costs
  2. B12%, addressing the lender's need to assess the entity's ability to generate returns on funds providedCorrect
  3. C15%, addressing the employees' need to assess job security
  4. D12%, addressing only the tax authority's need to assess taxable profit

Explanation

Profit before interest and tax is the profit from operations of $120,000 because finance costs are deducted after it. ROCE = 120,000 / 1,000,000 = 12%. The 10% option wrongly deducts finance costs of $20,000. The ratio informs lenders and investors about returns generated on capital provided, not tax.

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