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ACCA Applied Skills · Financial Reporting · Calculation and interpretation of accounting ratios and trends to address users' and stakeholders' needs

Zeta Co has the following figures at 31 December 20X5: ordinary share capital $2,000,000; retained earnings $3,000,000; 6% loan notes $1,500,000; bank overdraft $200,000; 5% irredeemable preference shares $500,000. Using the formula debt / equity, where debt includes preference shares and interest-bearing borrowings (including overdraft) and equity is ordinary share capital plus reserves, what is the gearing ratio?

Gearing is 44%. Debt of $2.2m (loan notes $1.5m, overdraft $0.2m and preference shares $0.5m) is divided by equity of $5m (share capital plus retained earnings). Leaving out the overdraft would understate the ratio at 40%.

  1. A40%
  2. B44%Correct
  3. C30%
  4. D34%

Explanation

Debt = 1,500,000 + 200,000 + 500,000 = 2,200,000. Equity = 2,000,000 + 3,000,000 = 5,000,000. Ratio = 2,200,000 / 5,000,000 = 44%. Excluding the overdraft gives 40%, which ignores interest-bearing borrowing.

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