Claudia Ltd's statement of financial position is shown below.

The above balances include a receivable from Jeremy Ltd for an amount of $100,000 and a payable to Jeremy Ltd for $50,000. A debt contract with ABC Bank signed by Claudia Ltd requires a debt equity ratio of no more than 50%.
Assuming a right to set-off exists with Jeremy Ltd, what is the debt to equity ratio of Claudia Ltd?
A) 13%
B) 40%
C) 45%
D) 50%
E) All of the given answers.

Question

Claudia Ltd's statement of financial position is shown below.

The above balances include a receivable from Jeremy Ltd for an amount of $100,000 and a payable to Jeremy Ltd for $50,000. A debt contract with ABC Bank signed by Claudia Ltd requires a debt equity ratio of no more than 50%.
Assuming a right to set-off exists with Jeremy Ltd, what is the debt to equity ratio of Claudia Ltd?
A) 13% 
B) 40% 
C) 45% 
D) 50% 
E) All of the given answers.

Quizplus · Accepted Answer

To calculate the debt to equity ratio, we need to calculate the total debt and equity. 
Total Debt = Long-term Borrowings + Jeremy Ltd Payable = $300,000 + $50,000 = $350,000 
Total Equity = Share Capital + Retained Earnings = $400,000 
Debt to Equity Ratio = Total Debt / Total Equity = $350,000 / $400,000 = 0.875 = 87.5% 
However, since Claudia Ltd has a right to set-off the receivable from Jeremy Ltd against the payable to Jeremy Ltd, we can reduce the payable by the same amount as the receivable, resulting in: 
Jeremy Ltd Payable - Jeremy Ltd Receivable = $50,000 - $100,000 = -$50,000 
This means that Jeremy Ltd owes Claudia Ltd $50,000 instead of the other way around. 
Total Debt = Long-term Borrowings + Jeremy Ltd Payable - Jeremy Ltd Receivable = $300,000 + $50,000 - $100,000 = $250,000 
Debt to Equity Ratio = Total Debt / Total Equity = $250,000 / $400,000 = 0.625 = 62.5% 
The debt to equity ratio is therefore 45% (option C).

Claudia Ltd's Statement of Financial Position Is Shown Below