ACCA Applied Knowledge · Financial Accounting · Ratios
Extracts from a company's statement of financial position: ordinary shares $400,000; retained earnings $300,000; 5% redeemable preference shares (classified as equity) $100,000; 10% loan notes $250,000; bank overdraft $50,000 (repayable on demand). Using debt / equity, where debt includes preference shares and the overdraft ignored as not long-term, and equity is ordinary shares plus reserves only, what is gearing?
Gearing is 50.0%. Debt is the $250,000 loan notes plus $100,000 preference shares, giving $350,000, and equity is $700,000 of ordinary shares and retained earnings. Leaving out the preference shares would wrongly give 35.7%.
- A35.7%
- B50.0%Correct
- C43.8%
- D31.3%
Explanation
Debt = loan notes 250,000 + preference shares 100,000 = 350,000. Equity = 400,000 + 300,000 = 700,000. Ratio = 350/700 = 50.0%. Excluding preference shares gives 35.7%, a missed inclusion.
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