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ACCA Applied Knowledge · Financial Accounting · Importance and purpose of analysis of financial statements

Alpha Co and Beta Co operate in the same industry. Alpha depreciates equipment over 5 years straight-line, while Beta depreciates similar equipment over 10 years straight-line. Which statement best describes the effect on a comparison of their return on capital employed?

Beta uses a longer depreciation period, so it reports lower depreciation and higher profit than Alpha for similar assets. Its ROCE therefore tends to look better, not because of real efficiency but because of differing accounting policies, which limits the comparability of ratios between companies.

  1. AComparison is unaffected because depreciation is a non-cash item
  2. BBeta's ROCE will tend to appear higher, so the comparison is distorted by differing accounting policiesCorrect
  3. CAlpha's ROCE will tend to appear higher because it has a higher asset base
  4. DComparison is only distorted if the companies have different tax rates

Explanation

Beta's longer useful life gives a lower annual depreciation charge, so higher profit, and a higher carrying amount of assets. Higher profit relative to the asset base typically gives Beta a higher ROCE, so the comparison is distorted by policy differences. Alpha's faster depreciation reduces both profit and asset values, so option C is wrong.

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