GRADE 11 – ACCOUNTING
PARTNERSHIPS: ANALYSIS & INTERPRETATION OF FINANCIAL STATEMENT
DEBT – EQUITY RATIO
TASK 7.10 – DEBT-EQUITY & GEARING (p.274 – 275)
Workings Answer
Debt-equity = Non-current liabilities ÷ Owners Equity
7.10.1 0.025 or 0.03 : 1
= 1 000 ÷ 40 000
Interest on FD = P X R X T
7.10.2 R1 400 p.a
= 20 000 X .7% X 12/12
Return on equity = Interest earned on FD ÷ Owners Equity
7.10.3 3.5%
= 1 400 ÷ 40 000 x 100/1
Debt-equity = Non-current liabilities ÷ Owners Equity
7.10.4 = (50 000 + 1 000) ÷ 40 000 1.27 or 1.3 : 1
= 51 000 ÷ 40 000
Fixed deposit = 20 000 + 50 000 = 70 000
Loan = 50 000
Therefore:
7.10.5 Interest on FD = 70 000 X 7% X 12/12 = 4 900 p.a (Income) R2 900 profit
Interest on loan = 50 000 X 4% X 12/12 = 2 000 p.a (Expense)
Profit or Loss = Income – Expense
= 4 900 – 2 000
Return on equity = Net Profit ÷ Owners Equity
7.10.6 7.25%
= 2 900 ÷ 40 000 x 100/1
Yes. It pays to borrow at 4% because I would be earning 7% on the amount invested, which increases the overall return on equity to
7.10.7
7,25%.
No - the interest rate on the loan is higher than the rate on the investment. I would earn less than I did before taking out the loan.
Interest:
Interest income = 70 000 x 7% x 12/12 = R4 900
7.10.8 Interest expense = 50 000 x 8% x 12/12 = R4 000
If interest on loan was 8% :
Net Profit = 4 900 – 4000 = R900
% Return on equity drops to 2,25% from 7.25 % ( 900 ÷ 40 000 x 100/1)
If the money borrowed can be utilised at a rate higher than the rate on the loan, my returns will be ‘geared up’ (favourable gearing).
7.10.9
The percentage of return on investment from borrowed money is more that than the interest rate on the borrowed money.
GRADE 11 – ACCOUNTING
PARTNERSHIPS: ANALYSIS & INTERPRETATION OF FINANCIAL STATEMENT
RETURN ON EQUITY
TASK 7.12 – Partners’ equity and Gearing (p.276)
No. Workings Answer
Average partners’ equity :
(Net profit ÷ Average Owner’s Equity) x 100 ÷ 1
2006 (closing) 2005 (opening)
= 152 250 ÷ [( Capital: Naidoo + Capital: Martin + Current account Naidoo + Current account Martin) + (Capital: Naidoo + Capital: Martin + Current account Naidoo + Current account
19.95%
Martin) ÷ 2] x 100 ÷ 1
7.12.1 or
= 152 250 ÷ [(420 000 + 380 000 + 20 000 + 5 000) + (360 000 + 330 000 + 8 000 + 3 000)÷ 2] x 100 ÷ 1 20%
= 152 250 ÷ [(825 000 + 701 000) ÷ 2] x 100 ÷ 1
= (152 250 ÷ 763 000) x 100 ÷ 1
Partner earnings or Amount earned by a partner:
7.12.2 Naidoo’s earnings = Primary distributions + Secondary distributions 94 500
= Salary + Interest on capital + share of remaining net profit
= 60 000 + 19 500 + 15 000
Partner earnings or Amount earned by a partner:
Martin’s earnings = Primary distributions + Secondary distributions
= Salary + Interest on capital + share of remaining net profit
7.12.3 57 750
= 30 000 + 17 750 + 10 000
OR
Martin’s earnings = Net profit – Naidoo’s earnings
= 152 250 – 94 500
% Return earned by each partner:
Naidoo = amount earned by the partner ÷ average equity of partner x 100/1
= 94 500 ÷ [(420 000 + 20 000) + (360 000 + 8 000) ÷ 2] x 100/1
7.12.4 23.4%
= 94 500 ÷ [(440 000 + 368 000) ÷ 2 ] x 100/1
= 94 500 ÷ 404 000 x 100/1
% Return earned by each partner:
Martin = amount earned by the partner ÷ average equity of partner x 100/1
= 57 750 ÷ [(380 000 + 5 000) + (330 000 + 3 000) ÷ 2] x 100/1 16.09%
7.12.5 or
= 57 750 ÷ [(385 000 + 333 000) ÷ 2 ] x 100/1 16.1%
= 57 750 ÷ 359 000 x 100/1
Debt : Equity ratio
2006:
Debt-equity = non-current liabilities ÷ owners equity 0.24: 1
= 200 000 ÷ ( 420 000 + 380 000 + 20 000 + 5 000)
= 200 000 ÷ 825 000
7.12.6
2005:
Debt-equity = non-current liabilities ÷ owners equity 0.43 : 1
= 300 000 ÷ ( 360 000 + 330 000 + 8 000 + 3 000)
= 300 000 ÷ 701 000
Note: In this case you are assessing the degree of risk on a certain day (i.e. the end of the financial year), so the average figures are not used.