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Hello,
I don’t fully understand what capital employed actually is as there is a number of different formulas for calculating it and they are contradictory. For example,
Formula 1: Capital employed = Total assets – current liabilities
Formula 2: Capital employed = Equity + all interest-bearing liabilities (including overdraft)
Second formula includes overdraft in the capital employed figure, but first formula excludes it as part of current liabilities.
Also, second formula includes only interest bearing non-current labilities in capital employed while first formula takes total non-current liabilities.
Could you please clarify what capital employed actually is and why formulas used to calculate it are so contradictory?
Thank you.
Hi,
Both formulae are correct as they are effectively using the accounting equation. The overdraft is correctly included in each as in the first we are starting with the total assets figure, whereas in the second we are starting with the equity figure.
To calculate it correctly then it depends on the information given in the question that can be used. If you’re given assets and liabilities then use the first formula, if not then you’ll have the information for the second formula instead.
Thanks
Good evening
Please can you help me understand the below.
Why when calculating ROCE, ignoring the associate we subtract the “Investment in associate” Non-current Asset on BS from the capital employed figure?
Capital employed is either:
1) Equity plus LTD
2) Total Assets less current LiabilitiesIf we used no. 2 I understand that Equity and LTD would be less if Total assets is reduced.
If we use no. 1 does it assume we financed this investment through debt so LTD would increase. If we remove the associate from the question then LTD would decrease?
What would the JNL entries be on investment in associate?
Dr Bank
Cr Non-current liabilitiesDr Non-current assets
Cr BankHi,
We ignore/remove the investment in associate when calculating capital employed as the profit figure does not include any income from the associate.
Whichever of you ways of calculating the capital employed, you need to remove the investment in associate.
On your associate journal entries then initially when we purchase it we DR Investment in associate CR Bank. Subsequently we DR Investment in associate CR Share of profit of associate with our share of the associate’s profit for the year.
Thanks
Hello,
Unfortunately I am still struggling to understand what the capital employed actually is… 🙁
In some sources it is referred to as a comapny’s assets. At the same time we deduct financial assets when calculaing Capital employed. What is more there is stand alone ration that measures efficiency with which company uses its assets and which uses total assets (which makes sense) – Return on assets.
In other sources capital employed reffered to as comapnies funds.
Sometimes it is reffered to as Net Assets but net assets is Equity only and the Capital employed formula includes interest bearing liabilities as well.
I need to understand this in general but also because it will them help me to make sense of ROCE, Asset turnover and other ratios that use capital employed.
So, what it acctually is? Could you please help me to understand?
I would trully appreciate your help with this!
Thank you.
Hi,
Capital employed is equity plus net debt, don’t go any further than this as otherwise you will get confused.
If think your confusion arises from your asset turnover and net asset turnover ratios. Asset turnover uses the total assets, whereas net asset turnover uses the capital employed.
Thanks
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