Inconsistency : Gearing formula, anyone else?

reddwarf Registered Posts: 528 Epic contributor 🐘
We debated in class whether the formula for gearing should include long term debt in Capital Employed we all agreed it should including our lecturer, who said without the long term debt the ratio is not meaningful.

The Dec 2009 question on ratios for Hoys ltd does not include the longer term debt in Capital Emloyed and this means the % is high leading to an assessement that the company is more highly geared than the industry average, which would make your analysis of the company very different from that if their gearing were low/er.

Is anyone else having this dilema or are you all exlcuding long term debt in Capital in this ratio?

Thanks for your thoughts


  • tigger37
    tigger37 Registered Posts: 200 Dedicated contributor πŸ¦‰

    If I recall from when I took the exam in December, either method is ok and you will get the marks.
  • katz568
    katz568 Registered Posts: 93 Regular contributor ⭐
    Apparantly it doesn't matter if you use the Debt/equity ratio or the full on gearing ratio (as I remember them, full on one including longterm debt) in the exam. What confused us was the fact that we had been taught the full on one for units 8/9 and then in the osborne book for DFS it stated the gearing ratio as debt/equity.
    You will still get all your marks whichever one you use as long as the answer is correct for the ratio formula used (why its so important to write formula out as well as numbers/rest of workings).
    We will all be ok (so she whom still has a lot to learn that hasn't been taught, even though we are supposed to be going onto past papers on thursday)
  • coojee
    coojee Registered Posts: 794 Epic contributor 🐘
    The important thing is to be consistent so that you are always comparing like with like. If you're given an industry average that is calculated as Debt/Equity then you must calculate gearing in the same way. In this question the industry average was debt/equity - it's hidden but you are given the information. Next to the industry average figure it tells you what Hoys 2008 gearing figure was, you need to check this to see which one it is. They tell you it's 76.26% which can only be calculated by using debt/equity (8000/10491). So you MUST use debt/equity so that you're being consistent.

    The chief assessor report says on this subject:

    "a significant proportion ignored the obvious clue to which form of the gearing ratio to use"

    So you would lose marks if you used the wrong formula.

    Always, always, always check which form of gearing ratio you are expected to use. You will lose marks if you use the wrong one.
  • reddwarf
    reddwarf Registered Posts: 528 Epic contributor 🐘
    Thanks Peeps, Cojee it was the % debt equity figure for 2008 that prompted the discussion I had calculated all of the 2008 ratios, thinking they'd be useful, but other didn't so they didn't pick it up.

    Something to watch out for on the day.

  • A-Vic
    A-Vic Registered Posts: 6,970 Beyond epic contributor πŸ§™β€β™‚οΈ
    you may have to watch which one to use as we found in december sitting they used a certain ratio and to compaire you had to use the same formula (dec 09)
  • jewels.p
    jewels.p Registered Posts: 1,774 Beyond epic contributor πŸ§™β€β™‚οΈ
    In my books it says you can use either method so I chose to learn the Debt/Equity one but as Vic said in the Dec 09 paper it told you which one to use. What is the difference between Equity and Capital Employed? Hope they dont ask for the Capital Employed one cause I dont know it!
    NO BUSINESS CASE Registered Posts: 85 Regular contributor ⭐
    Equity is just that the equity in the company (share cap+prem + retained earn) whilst Capital employed is equity + long term liabilities (ie Loans)
    DAVID LAWES Registered Posts: 29 Regular contributor ⭐
    Gearing ratio

    Sorry to be pedantic, but aren't preference shares and debentures included as "debt" in the top half of the gearing ratio, as well as loans?. I don't recall this point coming up in recent DFS exams because they haven't (yet) identified preference shares and debentures on a balance sheet on which ratios are to be calculated. But something tells me that one day they will....
  • reddwarf
    reddwarf Registered Posts: 528 Epic contributor 🐘
    Good thought!
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