ExpertMinds LogoExpertMinds
Medium1 markMultiple Choice
Interpretation of financial statementsRatio AnalysisInterpretationGearingMTQ

ACCA · Question 65 · Interpretation of financial statements

Section B - Case 2: Single Entity Accounts & Ratio Analysis

*Scenario: Horizon Wind Farms Ltd has prepared draft financial statements for the year ended 31 December 20X8. The draft net profit is $850,000. Draft Revenue is $4,000,000 and Cost of Sales is $2,200,000. The following adjustments have not yet been processed:

  1. Depreciation on new turbines of $50,000 was omitted.
  2. An annual insurance premium of $12,000 paid on 1 July 20X8 was expensed in full.
  3. Closing inventory was overvalued by $30,000.
  4. An irrecoverable debt of $15,000 needs to be written off.
    Equity comprises Share capital $1,000,000 and Retained earnings $2,000,000. There is a long-term loan of $1,500,000.*

Horizon Wind Farms operates in a highly capital-intensive industry. Which of the following statements best interprets their gearing ratio of 33.3%?

Answer options:

A.

The company is highly geared and at immediate risk of bankruptcy

B.

The company has a relatively low level of financial risk, as equity financing significantly exceeds debt financing

C.

The company relies entirely on external lenders to fund its operations

D.

The gearing ratio indicates the company is highly efficient at collecting receivables

How to approach this question

Evaluate the 33.3% figure. Gearing below 50% is generally considered low/moderate. It means the company is funded more by equity than by debt, implying lower financial risk (lower mandatory interest payments).

Full Answer

B.The company has a relatively low level of financial risk, as equity financing significantly exceeds debt financing✓ Correct
A gearing ratio of 33.3% indicates that only one-third of the company's long-term capital comes from debt, while two-thirds comes from equity. This is a relatively low level of gearing, indicating lower financial risk, as the company is not overly burdened by mandatory interest payments and capital repayments.

Common mistakes

Assuming any presence of a large loan ($1.5m) automatically means the company is 'highly geared' without looking at the proportion to equity.
64All questions

Practice the full ACCA FA — Financial Accounting Practice Exam 1

65 questions · hints · full answers · grading

Sign up freeTake the exam

More questions from this exam

Q01**Section A** BioGenix Ltd, a pharmaceutical startup, has spent $2 million on researching a new ...MediumQ02**Section A** Which of the following bodies is primarily responsible for issuing International F...EasyQ03**Section A** SolarTech Manufacturing recently upgraded its primary assembly line. Which TWO of ...MediumQ04**Section A** AgriGrow Ltd sells specialized farming equipment. A customer purchases a tractor f...MediumQ05**Section A** Oceanic Logistics provides shipping services. They issue an invoice for $10,000 to...Medium
View all 65 questions →