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am still stuck on the interest bit. here is the problem
p/l
revenue ……………. 20,500
cogs…………………..(18,000)
gp………………………..2500
oper. exp …………….. (500)
finance costs – loan …(300)
—overdraft ……………(10)
—lease ………………..(290)
profit b/tax ……………1400
income tax……………..(400)
orofit for the year ……1000the answer says PBIT=2500-500-10
10 is the interest on OD.
a note to the problem states: for the purpose of ROCE and gearing, all finance lease obligations are treated as long term interest bearing borrowings.
why is pbit taking into account the interest on OD?
why is pbit NOT taking into account the interest on lease of 290?The 290 lease interest is …. interest. Just like the 300 loan interest. The 10 overdraft interest has been treated as “just another expense” though I would probably have treated it as interest on a long term borrowing. As I’ve told you before in earlier posts on a different thread – it really depends upon the nature and purpose of the overdraft.
If it’s in the nature of a long term loan, then interest will be treated the same as loan interest.
If the overdraft is in the nature of volatile working capital requirement, then it isn’t long term financing
The key is the “CE” in the acronym “ROCE” Is an overdraft “capital employed” or is it simply a current liability likely to move up and down with the seasons / weeks / days / time of day?
“Capital Employed” is long term capital employed – like a loan or a finance lease
Better?
yes…. i totally understand what u r saying here and in the previous post. but how do we know if od is being treated as capital employed? we r given at best one year prior figures for comparison.
so it seems that for exam questions it is safer to treat od as an operational expense unless the question states otherwise. correct?
the reason am trying to get this is because in a multiple choice question, i have seen answers like 14% or 14.1. so the gap is so thin one wdnt know what to do.
this question however is a preparation question and am pretty sure inclusion or exclusion wdnt affect the percentage that much.
so.. as final word .. i will treat od as operational expense unless indicated otherwise. ok?
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once u reply….i will ask u about the denominator… the CE bit in ROCE .. 🙂
I think that you’ll probably find that the overdraft interest is either too small to have any affect – even the .1% that you mention – or it will be so substantial that it’s clearly capital employed
In your example the 10 overdraft interest compared with 300 loan interest and 290 finance lease interest. It’s hardly in the same class, is it?
I mentioned earlier that I would likely have treated it as long term interest but, thinking about it deeper, it’s hardly likely – just on materiality grounds
NOW TO THE DEMONIC DENOMINATOR
CE = total assets – CL or
CE = Shareholder Equity +NCL … these 2 are by definition. correct?same question as above ….
total assets = 14800
equity = 2800NCL:
finance lease obligations …. 3200
7% loan notes ………………. 3000
def tax ………………………… 100CL:
od ……………………….1200
payables………………..3800
fin lease obligations …. 500
taxation ………………… 200
total CL ………………… 5700
Note:
1. for ROCE capital employed taken as shareholder funds plus long term interest bearing borrowings.
2. for the purpose of ROCE and gearing, all finance lease obligations are treated as long term interest bearing borrowings.so the answer states that CE = 2800 + 3200+3000+500 = 9500
but if we apply the definition
CE=total assets – CL = 14800 – 5700 = 9100
my question: that he defines CE in the note given, means we ignore the definition for these 2 ratios? whats the point of this? what is being tested? that we can read and follow instructions??
Just think about the underlying meaning behind those two words …. capital employed.
This means funds that have been made available to the entity for the entity to use and generate profits. But these funds come at a cost …. either the providers want dividends (equity / shareholders’ funds) or the providers want interest (long term debt)
Which of those current liabilities wants some return on their asset? The finance lease liabilities do – they want finance lease interest. The taxman will want interest too – but only if we’re late paying the liability. Payables may want some rate of interest – but they can want because we’re not paying any! The overdraft is a tricky one – as stated earlier in this thread. Is it really capital employed? Maybe, but it’s not long-term capital employed.
That leaves us with the Deferred Tax Account balance shown in non-current liabilities. Does the 100 balance represent funds available? Or is it more in the nature of an accountant’s prudence to say that this 100 is not yet due (and may in fact never be due by the entity investing wisely) but the accountant is recognising that it may become due. It’s hardly funds being made available to the entity for investment or for the generation of profits.
The notes in the question are to give you guidance – otherwise there would be so many combinations of available answers that it would be a markers’ nightmare. yes, ok, it seems that the question is trying to determine whether you can follow instructions. But the purpose of a ratio calculation is so that you may then have something that you can interpret. The marks will not likely lean heavily towards the calculation – it’s the chat that will score
When tutors / books / FSA / IASB / FASB talk about ROCE and its definition(s) they really ought to explain what “Return” and on “capital employed” really is trying to show and the answer is not simply PBIT / TALCL. More thought is needed!
Is that ok now?
excellent summary.
and i agree with u.. the chat part is where the marks are.
i am concentrating on the interpretation by the way. i am writing what i think is correct then reading the answer to look at missing points.
for example, i had calculated the roce to be 65% and actually it was 71%. but the interpretation wasnt going to change since prior year roce was 35%.
i figure i may get just one point for the wrong ratio number but the chat shd get me marks.
i think this is it for the ratios… a big THANKS.
————————————————————————next stop is not for profit then i start revising.
am thinking about ignoring the bit about cash accounting and other methods of accounting. shd i?
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one question: am using text applicable till jun 15. now, they have changed the revenue from isa 18 to ifrs 15. i really dont want to buy the new text. what to do?
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