How will the components of the return on capital employed ratio be affected if a company charges depreciation too slowly? A Return will be understated and capital employed will be overstated. B Return will be overstated and capital employed will be overstated. C Return will be overstated and capital employed will be understated. D Return will be understated and capital employed will be understated why the answer is B is there any explanation or formula to prove this ?
There are a number of definitions of return on capital employed, but they are all variations on: return (ie profit) / capital If we think how depreciation comes into the accounts, it reduces profit and also reduces equity capital (through lower retained earnings being brought in for the year). So, putting these two pieces together, undercharging depreciation will lead to profit (ie return) being too high and also equity capital (and so capital employed) being too high.