sir i have a confusion. as gearing is also measured by the formula Total assets-current liabilities. in Qs 5 as we write of inventory it results in decrease of total assets so gearing should decrease…then why is the correct answer increasing ?
Gearing is not measured as total assets minus current liabilities!!
It is measured as long-term debt divided by equity plus long-term debt. Equity plus long-term debt is equal to total assets less current liabilities. If inventory is written off then total assets less current liabilities decreases. Since this is the denominator in the formula for the gearing ratio, the gearing ratio will increase.
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Do we get these ratios on a formula sheet during the exam?
no please
No you don’t. The formulae that you are given in the exam are on the formula sheet that is printed near the front of our free lecture notes.
sir i have a confusion. as gearing is also measured by the formula Total assets-current liabilities. in Qs 5 as we write of inventory it results in decrease of total assets so gearing should decrease…then why is the correct answer increasing ?
Gearing is not measured as total assets minus current liabilities!!
It is measured as long-term debt divided by equity plus long-term debt. Equity plus long-term debt is equal to total assets less current liabilities. If inventory is written off then total assets less current liabilities decreases. Since this is the denominator in the formula for the gearing ratio, the gearing ratio will increase.
Write off inventory question Nr 5 – The correct answer is ‘Increase Gearing Ratio’.
Please can you advise how write off inventory can influence gearing ratio?
For number 5 how does the write off of inventory increase the gearing ratio?
Writing off inventory will reduce the profit, which in turn reduces the total equity. Therefore the gearing will increase.
Thank you for clarifying 🙂
You are welcome 🙂