Question

Debt to Equity Ratio is 2. State giving reason, whether this ratio will increase or decrease or will not change in each of the following cases:

1. Purchase of a Fixed Asset on a credit of 3 months.
2. Sale of Fixed Asset (Book value 40,000) at a loss of ₹ 10,000 against cheque.
3. Cash Sale of Fixed Asset (Book Value ₹ 40,000) for ₹ 50,000.
4. Sale of Fixed Asset (Book Value ₹ 40,000) for ₹ 40,000.

Answer 1

1. Not Change
   Reason: A credit period of 3 months makes this transaction a current liability (Trade Payables). Since the formula only considers long-term debt and equity, both Long-term Debt and Shareholders’  Equity remain completely unaffected.
2. Increase
   Reason: The loss of ₹10,000 reduces the accumulated profits, which decreases Shareholders’  Equity (the denominator). Since Long-term Debt remains unchanged, a decrease in the denominator increases the final ratio.
3. Decrease
   Reason: Selling an asset worth ₹40,000 for ₹50,000 generates a profit of ₹10,000, which increases Shareholders’  Equity (the denominator). Since Long-term Debt remains unchanged, an increase in the denominator decreases the final ratio.
4. Not Change
   Reason: Since the asset is sold exactly at its book value, there is no profit or loss generated from this transaction. Consequently, neither Long-term Debt nor Shareholders’ Equity undergoes any change.