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

An analyst is comparing the current ratio of a manufacturer with the average ratio for its industry. Which of the following is a valid limitation of this comparison?

The valid limitation is that companies within an industry may have different year ends, accounting policies and business mixes, so the industry average may not be a like-for-like benchmark. Differences can distort comparisons, and the average does not remove effects such as window dressing at individual entities.

  1. AIndustry averages are always calculated using the same policies and year ends as the manufacturer
  2. BCompanies in the industry may have different year ends, policies and business mixes, so the average may not be a suitable benchmarkCorrect
  3. CAn industry average removes the effect of window dressing at each company
  4. DIndustry averages are only available for entities with no inventory

Explanation

Industry averages combine entities that may have different year ends, accounting policies, sizes and product mixes. The average may therefore not be a like-for-like benchmark. It does not remove window dressing, and the other statements are false.

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