Question

Which one of the following correctly defines the retention ratio?

Equity rises $500,000; net plant and equipment falls $500,000

Cash rises $500,000; net plant and equipment falls $200,000; equity rises $300,000

Cash rises $500,000; accounts receivable falls $200,000; goodwill rises $350,000

Cash rises $500,000; net plant and equipment falls $500,000

 

Answer 1

The right option is (c).

 

Explanation:

Retention ratio basically states that what is the amount the company is keeping with itself from the earnings rather then distributing it to the shareholders as Dividends. It is the portion of earning that is kept back which can help in the growth of the company as the cash can be reinvested.

 

Option A and D:-

In both these options net plant and equipment falls by $500,000 and equity and cash rises respectively. This can mean that we sold some of our machinery and that's the cash balance increased therefore this cannot be the Retention Ratio.

 

Option B:-

In this we also see net plant and equipment fall by $300,000 and also equity rising by 200,000. This can mean that we sold a plant for $300,000 and maybe issued equity for $200,000 which can explain the increase in Cash of $500,000.

 

Option C is the correct answer :-

Here we can see that the cash rises by $500,000 but we haven't had any impact on net plant and equipment. Our accounts receivable also fell by $200,000 which means that we recieved cash from them but still we had $300,000 with us. An increase in Goodwill doesn't effect the cash in the business hence we must have retained that cash from previous year.

Option C is the correct answer.