Lesson Note on Interpretation of Accounts: Capital Employed and Working Capital Ratios for SSS 2

Class: Senior Secondary School 2 (SS2 / SSS2)
Term: Second Term
Week: 11
Age: 16 years
Duration: 45 minutes
Subject: Financial Accounting
Curriculum Theme: Financial Reporting
Previous Lesson: Accounting Ratios: Equity, Capital Employed and Working Capital.
Topic: FURTHER TREATMENT OF INTERPRETATION OF ACCOUNTS
Subject Matter: Capital employed, working capital, ways of interpreting accounts, 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 capital employed and working capital.
• List different ways of interpreting accounts.
• Explain the ratio of working capital to capital employed and the ratio of equity to capital employed.

Affective Domain:

• Appreciate the importance of interpreting financial accounts for business decision-making.
• Develop interest in analyzing financial statements.

Psychomotor Domain:

• Compute capital employed and working capital from given financial data.
• Calculate the ratio of working capital to capital employed.
• Calculate the ratio of equity to capital employed.

Social Domain:

• Collaborate with peers in discussing the interpretation of financial accounts.

Reference Materials

The following resources were used in planning this lesson:

• Senior Secondary Schools Education Curriculum
• State Unified Scheme of Work
• Financial Accounting for Senior Secondary Schools by O.A. Longe
• https://www.accaglobal.com/gb/en/student/exam-support-resources/fundamentals-exams-study-resources/f3/technical-articles/ratio-analysis.html
• https://www.investopedia.com/terms/c/capitalemployed.asp

Instructional Materials

The teacher will teach this lesson with the aid of:

• Charts showing financial statements
• Flash cards with accounting terms and formulas
• Whiteboard and markers

Rationale for the Lesson

This lesson helps pupils understand how to assess a company’s financial health and efficiency by interpreting key financial figures. It enables them to use important ratios to evaluate a business’s long-term and short-term financial structure, which is vital for informed decision-making.

Prerequisite/Previous Knowledge

Pupils should have a basic understanding of financial statements (Statement of Financial Position and Income Statement) and elementary ratio analysis.

Lesson Content/Board Summary

FURTHER TREATMENT OF INTERPRETATION OF ACCOUNTS

Capital Employed

Capital employed represents the total long-term funds invested in a business. It shows the total amount of capital used to generate profit.

Formula:

Capital Employed = Shareholders’ Funds + Long-term Loans

OR

Capital Employed = Total Assets – Current Liabilities

Working Capital

Working capital is the difference between a company’s current assets and its current liabilities. It indicates the liquidity of a business and its ability to meet short-term obligations.

Formula:

Working Capital = Current Assets – Current Liabilities

Ways of Interpreting Accounts

The following are common ways of interpreting financial accounts:

• Ratio Analysis: Using financial ratios to assess performance.
• Trend Analysis: Comparing financial data over several periods to identify patterns.
• Comparative Analysis: Comparing a company’s performance with that of competitors or industry averages.
• Common Size Statements: Expressing financial statement items as a percentage of a base figure.

Ratio of Working Capital to Capital Employed

This ratio measures the proportion of capital employed that is represented by working capital. It shows how much of the long-term funds are invested in the short-term operations of the business.

Formula:

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

Worked Example 1:
A company has Capital Employed of N1,500,000 and Working Capital of N300,000. Calculate the ratio of working capital to capital employed.

Step 1: Identify the given values.
Working Capital = N300,000
Capital Employed = N1,500,000

Step 2: Apply the formula.
Ratio = (N300,000 / N1,500,000) × 100%

Step 3: Calculate the ratio.
Ratio = 0.2 × 100% = 20%

Worked Example 2:
A firm has Current Assets of N600,000, Current Liabilities of N250,000, Shareholders’ Funds of N800,000, and Long-term Loans of N400,000. Calculate the ratio of working capital to capital employed.

Step 1: Calculate Working Capital.
Working Capital = Current Assets – Current Liabilities
Working Capital = N600,000 – N250,000 = N350,000

Step 2: Calculate Capital Employed.
Capital Employed = Shareholders’ Funds + Long-term Loans
Capital Employed = N800,000 + N400,000 = N1,200,000

Step 3: Apply the ratio formula.
Ratio = (Working Capital / Capital Employed) × 100%
Ratio = (N350,000 / N1,200,000) × 100%

Step 4: Calculate the ratio.
Ratio ≈ 0.2917 × 100% = 29.17% (rounded to two decimal places)

Ratio of Equity to Capital Employed

This ratio, also known as the equity ratio or gearing ratio (when viewed from a debt perspective), measures the proportion of capital employed that is financed by shareholders’ funds (equity). It indicates the financial stability and reliance on owner’s funds.

Formula:

Ratio of Equity to Capital Employed = (Shareholders’ Funds / Capital Employed) × 100%

Worked Example 1:
A company has Shareholders’ Funds of N700,000 and Capital Employed of N1,000,000. Calculate the ratio of equity to capital employed.

Step 1: Identify the given values.
Shareholders’ Funds = N700,000
Capital Employed = N1,000,000

Step 2: Apply the formula.
Ratio = (N700,000 / N1,000,000) × 100%

Step 3: Calculate the ratio.
Ratio = 0.7 × 100% = 70%

Worked Example 2:
A business has Share Capital of N400,000, Retained Earnings of N150,000, and Long-term Loans of N350,000. Calculate the ratio of equity to capital employed.

Step 1: Calculate Shareholders’ Funds.
Shareholders’ Funds = Share Capital + Retained Earnings
Shareholders’ Funds = N400,000 + N150,000 = N550,000

Step 2: Calculate Capital Employed.
Capital Employed = Shareholders’ Funds + Long-term Loans
Capital Employed = N550,000 + N350,000 = N900,000

Step 3: Apply the ratio formula.
Ratio = (Shareholders’ Funds / Capital Employed) × 100%
Ratio = (N550,000 / N900,000) × 100%

Step 4: Calculate the ratio.
Ratio ≈ 0.6111 × 100% = 61.11% (rounded to two decimal places)

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 greets the pupils and reviews the previous lesson on basic interpretation of accounts. The teacher then introduces the topic by asking pupils why businesses need to analyze their financial performance.
Pupils’ Activity: Pupils respond to the teacher’s questions and recall previous knowledge.
Learning Point: Pupils connect the new topic to prior learning and understand the relevance of financial analysis.

Step 2: Capital Employed and Working Capital

Time: 8 minutes
Teaching Skill: Explanation/Definition
Teacher’s Activity: The teacher defines “capital employed” and “working capital” using clear examples and illustrates their formulas on the board. The teacher uses charts to show how these figures are derived from financial statements.
Pupils’ Activity: Pupils listen attentively, ask questions for clarification, and copy definitions and formulas into their notebooks.
Learning Point: Pupils understand the meaning and calculation of capital employed and working capital.

Step 3: Ways of Interpreting Accounts

Time: 7 minutes
Teaching Skill: Listing/Discussion
Teacher’s Activity: The teacher guides pupils to list and briefly explain various methods used to interpret financial accounts, such as ratio analysis, trend analysis, and comparative analysis.
Pupils’ Activity: Pupils contribute ideas, list the methods, and discuss their understanding of each.
Learning Point: Pupils identify and understand different approaches to interpreting financial statements.

Step 4: Ratio of Working Capital to Capital Employed

Time: 8 minutes
Teaching Skill: Demonstration/Explanation
Teacher’s Activity: The teacher explains the significance of the ratio of working capital to capital employed. The teacher then demonstrates how to calculate this ratio using a worked example on the board, emphasizing each step.
Pupils’ Activity: Pupils observe the demonstration, follow the calculation steps, and ask questions.
Learning Point: Pupils learn the formula and method for calculating the ratio of working capital to capital employed.

Step 5: Ratio of Equity to Capital Employed

Time: 7 minutes
Teaching Skill: Demonstration/Explanation
Teacher’s Activity: The teacher explains the importance of the ratio of equity to capital employed. The teacher demonstrates the calculation of this ratio with another worked example on the board, detailing each step.
Pupils’ Activity: Pupils pay attention to the explanation and demonstration, noting the formula and calculation process.
Learning Point: Pupils understand the formula and method for calculating the ratio of equity to capital employed.

Step 6: Practice and Application

Time: 5 minutes
Teaching Skill: Problem Solving
Teacher’s Activity: The teacher provides a short practice question involving the calculation of both ratios and asks pupils to work it out in pairs or individually.
Pupils’ Activity: Pupils attempt to solve the practice question, applying the learned formulas and steps.
Learning Point: Pupils apply their knowledge to solve practical problems and reinforce their understanding.

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 capital employed.
2. What is working capital?
3. State two ways of interpreting accounts.
4. Given Shareholders’ Funds of N600,000 and Long-term Loans of N200,000, calculate Capital Employed.
5. If Working Capital is N150,000 and Capital Employed is N750,000, calculate the ratio of working capital to capital employed.

Pupils’ Activity: Pupils answer orally and in writing.
Learning Point: Pupils demonstrate understanding of the lesson.

Step 8: Conclusion

Time: 5 minutes
Teaching Skill: Summarization/Assignment
Teacher’s Activity: The teacher summarizes the key learning points about capital employed, working capital, ways of interpretation, and the two ratios. The teacher then gives pupils homework to research the ideal values or ranges for these ratios in different industries.
Pupils’ Activity: Pupils listen to the summary and note down the homework.
Learning Point: Pupils consolidate their understanding and are encouraged to extend their learning.

Lesson Keywords

• Capital Employed – Total long-term funds invested in a business.
• Working Capital – The difference between current assets and current liabilities.
• Ratio Analysis – A method of assessing financial performance using financial ratios.
• Equity – The shareholders’ funds in a company.
• Interpretation of Accounts – The process of analyzing financial statements to understand a company’s financial health.

Differentiation

For struggling learners, the teacher will provide simplified examples and extra guidance during calculations, focusing on one ratio at a time. Advanced learners will be challenged to analyze how different financial decisions might impact these ratios and explain their implications for a business.

Note for teachers using this lesson plan

Ensure that pupils have a strong grasp of basic financial statement components before introducing these advanced ratios. Encourage pupils to bring real-world examples of company financial statements for analysis if possible. Emphasize the practical application of these ratios in assessing business performance and making investment decisions.