ACCA Applied Skills · Financial Reporting · Limitations of interpretation techniques
Harlow plc's directors propose to assess the company's performance for a bank by comparing its year-end current ratio and gearing with those of a competitor, Brandt plc. Harlow's year end is 31 December, when its seasonal trade is at its lowest, whereas Brandt's year end is 30 June, at its seasonal peak. Which of the following is the most significant limitation of this comparison?
The key limitation is that the statement of financial position is a snapshot at one date. With year ends at opposite points of a seasonal cycle, balances are unrepresentative and differ systematically, so the current ratio and gearing of the two entities are not truly comparable.
- ARatios cannot be calculated from financial statements prepared under IFRS Accounting Standards
- BThe statements of financial position are snapshots taken at dates that are unrepresentative of each entity's typical position, so the ratios are not comparableCorrect
- CRatios based on historical cost always overstate the profitability of the entity with the later year end
- DComparing two entities in the same industry is invalid because their accounting policies must differ
Explanation
Statement of financial position figures reflect a single date. Where year ends fall at different points in a seasonal cycle, balances such as inventory, receivables and borrowings differ systematically, so ratios like the current ratio and gearing are distorted and not comparable. The other options are false generalisations: IFRS statements can be analysed, historical cost does not always overstate profit by year end date, and same-industry entities may share policies.
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