Question

Assertion (A): If Proprietary Ratio is 0.6 : 1 and Debt-Equity Ratio is 2 : 1, sale of a Fixed Asset costing ₹ 5,00,000 for ₹ 4,00,000 will decrease the Proprietary as well as Debt-Equity Ratio.

Reason (R): Proprietary Ratio will decrease because Shareholder’s Funds have decreased by the amount of loss but Debt-Equity Ratio will increase because Long-term Debts remain unchanged but Shareholder’s Funds have decreased.

In the context of the above two statements, which of the following is correct?

Options

• Both (A) and (R) are correct and (R) is the correct reason of (A).

• Both (A) and (R) are correct but (R) is not the correct reason of (A).

• Only (R) is correct.

• Both (A) and (R) are wrong.

Answer 1

Only (R) is correct.

Explanation:

A fixed asset worth ₹ 5,00,000 is sold for ₹ 4,00,000, resulting in a loss of ₹ 1,00,000 and a fall in Shareholders’ Funds. Thus, the Proprietary Ratio decreases. Also, long-term loans remain constant while equity falls, causing the Debt-Equity Ratio to increase rather than decrease. Therefore, Reason is correct.