Cima G1 Exam Study Material

Cima G1 Exam Question No 6:

The Group Finance Director has left you the following memo:
MEMORANDUM
To: Senior Management Accountant
From: Felicity Bunyan, Group Finance Director
Subject: Debt covenant

As you know, we have significant bank borrowings. The bank has put a number of 'debt covenants' in place. These are conditions that must be met if we are to be allowed to carry on with the loan. If we breach any of those conditions, the bank has the right to demand immediate repayment of their loan and to take possession of the assets that we have pledged as security in the event that we cannot afford to repay.

One of those conditions is that our gearing ratio cannot exceed 37% when we measure debt as a percentage of total long term finance.

Our gearing ratios were as follows over the past few years:

2012 32%
2013 34%
2014 33%
We have a problem on the horizon. As you are aware, in order to maintain flexibility, Bild has used operating leases to finance the majority of its construction equipment. Most of these leases are over three or five years.  Proposed changes to the rules relating to the accounting treatment of leases mean that we may have to recognise additional long term liabilities before the loans are due for repayment. Doing so will put us in technical default with respect to our debt covenant, pushing our gearing to around 40%. Please draft a paper for me that:

    Analyses our gearing position with respect to the nature of our business and its overall position.
    Suggests an approach that might be taken to negotiating a change to the loan conditions with the bank so that our technical default might be overlooked.