ExpertMedium2 marksMultiple Choice
ACCA · Question 13 · Analyzing and Interpreting Financial Statements
Section A
A company transitions from renting a factory on a short-term basis (expensed to P&L) to signing a 10-year lease, recognizing a significant Right-of-Use (ROU) asset and lease liability under IFRS 16.
Assuming operating profit remains exactly the same before and after the transition, what is the immediate impact on the Return on Capital Employed (ROCE) ratio?
Section A
A company transitions from renting a factory on a short-term basis (expensed to P&L) to signing a 10-year lease, recognizing a significant Right-of-Use (ROU) asset and lease liability under IFRS 16.
Assuming operating profit remains exactly the same before and after the transition, what is the immediate impact on the Return on Capital Employed (ROCE) ratio?
Answer options:
A.
ROCE will increase.
B.
ROCE will decrease.
C.
ROCE will remain unchanged.
D.
The impact cannot be determined without knowing the interest rate.
How to approach this question
Recall the formula for ROCE: Profit Before Interest and Tax / Capital Employed. Determine how recognizing a lease liability affects Capital Employed.
Full Answer
B.ROCE will decrease.✓ Correct
Return on Capital Employed (ROCE) is calculated as Operating Profit (PBIT) divided by Capital Employed (Total Assets - Current Liabilities, or Equity + Non-Current Liabilities). Recognizing a 10-year lease adds a significant lease liability (mostly non-current). This increases Capital Employed. Since Operating Profit is stated to remain the same, dividing the same profit by a larger capital base results in a lower ROCE.
Common mistakes
Thinking that because assets (ROU) and liabilities increase equally, the ratio stays the same. Ratios are fractions; adding the same amount to the denominator changes the result.
Practice the full ACCA FR — Financial Reporting Practice Exam 4
32 questions · hints · full answers · grading
More questions from this exam
Q01**Section A**
Under the IASB's Conceptual Framework for Financial Reporting, which of the follow...MediumQ02**Section A**
Cobalt Extraction Co operates a deep-sea mining vessel. The vessel cost $50 millio...MediumQ03**Section A**
CloudStream Inc provides a 12-month SaaS subscription to a client for $120,000, pa...HardQ04**Section A**
AeroFreight sold a cargo aircraft to a leasing company for its fair value of $40 m...HardQ05**Section A**
NeuroTech is developing a new neural-interface device. During the year ended 31 De...Easy