Page 499 - SBR Integrated Workbook STUDENT S18-J19

Answers

Chapter 22

Example 1

Ratios

The financial instrument should have been classified as a financial liability
because it contains a contractual obligation to transfer cash.

This means that Pigeon’s equity is overstated and its liabilities are
understated. The error will improve the gearing ratio, which may lead investors
to underestimate Pigeon’s financial risk.

Dividends on equity instruments are charged to retained earnings, whereas
interest on financial liabilities is charged to finance costs in the statement of
profit or loss. This means that Pigeon’s profits and earnings per share – a key
investor ratio – will also be overstated.

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