You are a financial analyst specialising in the analysis of the profitability of organisations in the engineering sector. One such company is D Ltd. The directors of D Ltd have always been interested in the impact of price changes on the performance of their business and have adopted the practice of including current cost accounts (using the ‘Real Terms’

system) alongside the historical cost accounts in the published financial statements.

Extracts from the published financial statements for the year ended 31 March 1996 are given below:

Requirements

(a) Compute (under both conventions) three accounting ratios for D Ltd which differ under the two conventions. (6 marks)

(b) Explain, for each ratio you have computed, the reason why the current cost elements included in the ratio differ from the historical cost elements. (9 marks)

(c) Explain the adjustments ‘Holding gains arising during the year’ and ‘Inflation adjustment to shareholders’ funds’. (5 marks)

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Profit and loss accounts - year ended 31 March 1996 Sales Operating costs (Note 1) Operating profit Interest payable Profit before taxation Taxation Profit after taxation Holding gains arising during the year Inflation adjustment to shareholders' funds Real gains Profit for the year Dividends Retained profit Historical cost 000 30000 (16000) 14000 000 Current cost 000 30000 (19000) 11000 (2000) 9000 (3500) (2000) 12000 (3500) 8500 5500 3500 (2000) 1500 8500 (7000) 7000 (7000) 1500