Lesson Note on Accounting Ratios: Equity, Capital Employed and Working Capital for SSS 2

Class: Senior Secondary School 2 (SS2 / SSS2)
Term: Second Term
Week: 10
Age: 16 years
Duration: 45 minutes
Subject: Financial Accounting
Curriculum Theme: Financial Accounting
Previous Lesson: Incomplete Records: Conversion to Final Accounts and Balance Sheet.
Topic: INTERPRETATION OF ACCOUNTS USING SIMPLE ACCOUNTING RATIOS EQUITY.
Subject Matter: Meaning of accounting ratios (tools for interpreting financial statements), equity, capital employed, working capital, ratio of working capital to capital employed, ratio of equity to capital employed.

Specific Objectives

By the end of the lesson, pupils should be able to:

Cognitive Domain:

• Define accounting ratios and explain their purpose.
• Identify key components like equity, capital employed, and working capital.
• State the formulas for the ratio of working capital to capital employed and the ratio of equity to capital employed.

Affective Domain:

• Appreciate the importance of accounting ratios in assessing business performance.
• Show interest in analyzing financial statements using ratios.

Psychomotor Domain:

• Compute the ratio of working capital to capital employed from given financial figures.
• Compute the ratio of equity to capital employed from given financial figures.

Social Domain:

• Discuss the implications of the calculated ratios for a business’s financial health.
• Collaborate in interpreting ratio results for decision-making.

Reference Materials

The following resources were used in planning this lesson:

• Senior Secondary Schools Education Curriculum
• State Unified Scheme of Work
• Oyedele, O. (2018). Simplified Financial Accounting for Senior Secondary Schools.

Instructional Materials

The teacher will teach this lesson with the aid of:

• Charts showing financial statements and ratio formulas.

Rationale for the Lesson

Understanding accounting ratios helps pupils to analyze the financial health and performance of a business. This knowledge is important for making informed business decisions and for evaluating investments, both in academic and real-world contexts.

Prerequisite/Previous Knowledge

Pupils have a basic understanding of financial statements such as the Statement of Financial Position (Balance Sheet) and Income Statement, and are familiar with terms like assets, liabilities, and capital.

Lesson Content/Board Summary

INTERPRETATION OF ACCOUNTS USING SIMPLE ACCOUNTING RATIOS

Meaning of Accounting Ratios

Accounting ratios are mathematical expressions that show the relationship between two or more financial statement items. They are important tools used to analyze a company’s financial performance, liquidity, solvency, and profitability.

Purpose of Accounting Ratios

Accounting ratios are used for:

• Assessing the financial performance and position of a business.
• Comparing a company’s performance over different periods (trend analysis).
• Comparing a company’s performance with other companies in the same industry.
• Aiding management in decision-making and planning.

Key Terms

• Equity: This represents the owner’s stake in the business. It is the residual interest in the assets of the entity after deducting all its liabilities. It is also known as owner’s capital or shareholders’ fund.
• Capital Employed: This refers to the total long-term funds invested in a business. It is calculated as Equity plus Long-Term Liabilities (e.g., debentures, long-term loans). Alternatively, it can be calculated as Net Assets (Fixed Assets + Working Capital).
• Working Capital: This is the difference between current assets and current liabilities. It represents the capital available to a business for its day-to-day operations.

  Formula: Working Capital = Current Assets – Current Liabilities

Simple Accounting Ratios

1. Ratio of Working Capital to Capital Employed

This ratio indicates the proportion of long-term funds (capital employed) that is used to finance the business’s working capital. A higher ratio can suggest better liquidity or under-utilization of long-term funds, depending on the context.

Formula:

Working Capital to Capital Employed Ratio = (Working Capital / Capital Employed) × 100%

Worked Example 1:

A company has Current Assets of ₦600,000, Current Liabilities of ₦250,000, and Capital Employed of ₦1,500,000.

Calculate the Ratio of Working Capital to Capital Employed.

Solution:

Step 1: Calculate Working Capital.

Working Capital = Current Assets – Current Liabilities

Working Capital = ₦600,000 – ₦250,000 = ₦350,000

Step 2: Apply the ratio formula.

Ratio = (Working Capital / Capital Employed) × 100%

Ratio = (₦350,000 / ₦1,500,000) × 100%

Ratio = 0.2333 × 100% = 23.33%

Worked Example 2:

A firm’s Statement of Financial Position shows: Ordinary Share Capital ₦800,000, Retained Earnings ₦200,000, 10% Debentures (long-term) ₦300,000, Current Assets ₦450,000, Current Liabilities ₦150,000.

Calculate the Ratio of Working Capital to Capital Employed.

Solution:

Step 1: Calculate Equity.

Equity = Ordinary Share Capital + Retained Earnings

Equity = ₦800,000 + ₦200,000 = ₦1,000,000

Step 2: Calculate Capital Employed.

Capital Employed = Equity + Long-Term Liabilities

Capital Employed = ₦1,000,000 + ₦300,000 = ₦1,300,000

Step 3: Calculate Working Capital.

Working Capital = Current Assets – Current Liabilities

Working Capital = ₦450,000 – ₦150,000 = ₦300,000

Step 4: Apply the ratio formula.

Ratio = (Working Capital / Capital Employed) × 100%

Ratio = (₦300,000 / ₦1,300,000) × 100%

Ratio = 0.2308 × 100% = 23.08%

2. Ratio of Equity to Capital Employed

This ratio measures the proportion of a company’s total long-term funds (capital employed) that is financed by its owners’ equity. A higher ratio indicates a lower reliance on external debt for long-term financing, suggesting financial strength and lower risk.

Formula:

Equity to Capital Employed Ratio = (Equity / Capital Employed) × 100%

Worked Example 1:

A business has Equity of ₦800,000 and Capital Employed of ₦1,200,000.

Calculate the Ratio of Equity to Capital Employed.

Solution:

Step 1: Identify Equity and Capital Employed.

Equity = ₦800,000

Capital Employed = ₦1,200,000

Step 2: Apply the ratio formula.

Ratio = (Equity / Capital Employed) × 100%

Ratio = (₦800,000 / ₦1,200,000) × 100%

Ratio = 0.6667 × 100% = 66.67%

Worked Example 2:

From the following figures, calculate the Ratio of Equity to Capital Employed:

• Share Capital: ₦1,500,000
• Retained Earnings: ₦500,000
• Long-term Loan: ₦700,000

Solution:

Step 1: Calculate Equity.

Equity = Share Capital + Retained Earnings

Equity = ₦1,500,000 + ₦500,000 = ₦2,000,000

Step 2: Calculate Capital Employed.

Capital Employed = Equity + Long-term Loan

Capital Employed = ₦2,000,000 + ₦700,000 = ₦2,700,000

Step 3: Apply the ratio formula.

Ratio = (Equity / Capital Employed) × 100%

Ratio = (₦2,000,000 / ₦2,700,000) × 100%

Ratio = 0.7407 × 100% = 74.07%

Teaching Methods/Instructional Techniques

Discussion, Lecture, Demonstration, Question and Answer, Visual Aids

Instructional Procedures

Step 1: Introduction

Time: 5 minutes

Teaching Skill: Set Induction

Teacher’s Activity: The teacher asks pupils what they understand by financial statements and how they can be used to assess a business. The teacher then introduces the topic of accounting ratios as tools for interpretation.

Pupils’ Activity: Pupils respond to the questions and listen attentively to the introduction of the new topic.

Learning Point: Pupils recall previous knowledge and are prepared for the new lesson.

Step 2: Meaning and Purpose of Accounting Ratios

Time: 5 minutes

Teaching Skill: Explanation

Teacher’s Activity: The teacher explains what accounting ratios are and their importance in interpreting financial statements.

Pupils’ Activity: Pupils listen, take notes, and ask questions for clarification.

Learning Point: Pupils understand the definition and significance of accounting ratios.

Step 3: Key Terms

Time: 7 minutes

Teaching Skill: Definition/Elaboration

Teacher’s Activity: The teacher defines and explains key terms such as Equity, Capital Employed, and Working Capital, using simple examples to illustrate each.

Pupils’ Activity: Pupils listen, write down the definitions, and ask questions to ensure understanding.

Learning Point: Pupils grasp the meaning of important financial terms related to the ratios.

Step 4: Ratio of Working Capital to Capital Employed

Time: 10 minutes

Teaching Skill: Demonstration/Calculation

Teacher’s Activity: The teacher presents the formula for the Ratio of Working Capital to Capital Employed. The teacher then works through examples on the board, showing step-by-step calculations and interpretations.

Pupils’ Activity: Pupils copy the formula and examples, follow the calculations, and attempt to solve similar problems.

Learning Point: Pupils learn how to calculate and interpret the Ratio of Working Capital to Capital Employed.

Step 5: Ratio of Equity to Capital Employed

Time: 10 minutes

Teaching Skill: Demonstration/Calculation

Teacher’s Activity: The teacher introduces the formula for the Ratio of Equity to Capital Employed. The teacher then provides and solves more examples on the board, guiding pupils through the computation and interpretation.

Pupils’ Activity: Pupils engage in the calculation process, ask questions about specific steps, and ensure they understand the interpretation.

Learning Point: Pupils learn how to calculate and interpret the Ratio of Equity to Capital Employed.

Step 6: Interpretation of Ratios

Time: 3 minutes

Teaching Skill: Discussion

Teacher’s Activity: The teacher facilitates a brief discussion on what a high or low value for each ratio might suggest about a company’s financial position.

Pupils’ Activity: Pupils contribute to the discussion by offering their interpretations and insights.

Learning Point: Pupils develop critical thinking skills in analyzing ratio results.

Step 7: Evaluation/Review

Time: 5 minutes

Teaching Skill: Questioning/Assessment

Teacher’s Activity: The teacher evaluates the learning by asking the following questions:

1. Define accounting ratios.
2. State the formula for calculating working capital.
3. Explain what capital employed means.
4. If a company has Equity of ₦500,000 and Capital Employed of ₦800,000, calculate the Ratio of Equity to Capital Employed.

Pupils’ Activity: Pupils answer orally and in writing.

Learning Point: Pupils demonstrate understanding of the lesson.

Step 8: Conclusion

Time: 2 minutes

Teaching Skill: Summarization

Teacher’s Activity: The teacher summarizes the key learning points about accounting ratios, emphasizing their importance in financial analysis. The teacher then assigns homework to reinforce the concepts taught.

Pupils’ Activity: Pupils listen to the summary and copy down the assigned homework.

Learning Point: Pupils consolidate their understanding of the lesson and prepare for further practice.

Lesson Keywords

• Accounting ratios – Mathematical expressions showing relationships between financial statement items.
• Equity – Owner’s stake in a business; owner’s capital.
• Capital employed – Total long-term funds invested in a business.
• Working capital – Current assets minus current liabilities, used for day-to-day operations.

Differentiation

For pupils who grasp concepts quickly, the teacher can provide more complex scenarios or additional ratios to calculate and interpret. For pupils who require more support, the teacher will offer one-on-one guidance, simplify examples, and provide additional practice questions focusing on basic calculations.

Note for teachers using this lesson plan

Ensure that pupils have a strong foundation in understanding basic financial statement components before introducing ratios. Use clear, simple language and concrete examples to explain complex terms. Encourage active participation and provide ample opportunities for pupils to practice calculations and interpret results. Emphasize that ratios are more meaningful when compared over time or against industry averages.