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 first calculate the total debt and total equity of Claudia Ltd. Total debt is calculated as the sum of current liabilities ($200,000), long-term liabilities ($300,000) and the receivable from Jeremy Ltd ($100,000), which gives us a total debt of $600,000. Total equity is calculated as the sum of share capital ($400,000) and retained earnings ($300,000), which gives us a total equity of $700,000.

Using these figures, the debt to equity ratio is calculated as follows:

Debt to equity ratio = Total debt / Total equity 
Debt to equity ratio = $600,000 / $700,000 
Debt to equity ratio = 0.857 or 85.7%

However, we also need to consider the right to set-off with Jeremy Ltd. Since Claudia Ltd has a receivable from Jeremy Ltd of $100,000 and a payable to Jeremy Ltd of $50,000, these two amounts can be set off against each other. This means that the net receivable from Jeremy Ltd is $50,000 ($100,000 - $50,000).

Therefore, the total debt is reduced by $50,000 to $550,000 ($600,000 - $50,000).

The debt to equity ratio is now calculated as follows:

Debt to equity ratio = Total debt / Total equity 
Debt to equity ratio = $550,000 / $700,000 
Debt to equity ratio = 0.785 or 78.5%

Since Claudia Ltd's debt to equity ratio is less than 50%, it satisfies the debt equity ratio requirement of the debt contract with ABC Bank.

The correct answer is C, 45%.

Claudia Ltd's Statement of Financial Position Is Shown Below