ACCA Applied Knowledge · Financial Accounting · Ratios
Company A and Company B operate in the same industry. Company A depreciates equipment over 4 years and Company B over 8 years, both straight line. Which statement best describes the effect on comparing their ratios?
Different depreciation policies change reported profit and net asset values, so margins, asset turnover and return on capital employed are not directly comparable until adjusted. Compliance with IFRS does not guarantee comparability, because acceptable policies and estimates can still differ between companies.
- ACompany A's return on capital employed will always be higher because depreciation is higher
- BRatios such as asset turnover and operating margin are not directly comparable without adjusting for the policy differenceCorrect
- CThe difference has no effect because both comply with IFRS
- DOnly liquidity ratios will be affected by the difference
Explanation
Different depreciation policies change profit and carrying amounts of assets, which affects margins, ROCE and asset turnover. Both may comply with IFRS, yet comparability is reduced. The claim that A's ROCE is always higher is wrong, since lower profit and lower assets move the ratio in uncertain ways.
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