Skip to content

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

Zeta Co and Omega Co operate in the same industry. Zeta uses the straight-line method of depreciation and Omega uses the reducing balance method for identical machines of the same age. Which limitation of ratio analysis does this MOST directly illustrate?

It illustrates that differing accounting policies reduce comparability. Using straight-line versus reducing balance depreciation produces different profits and asset carrying amounts for identical assets, so ratios such as return on capital employed and profit margin are not directly comparable between the two entities without adjustment.

  1. ARatios cannot be calculated for entities in the same industry
  2. BDifferences in accounting policies reduce the comparability of ratios between entitiesCorrect
  3. CRatios are distorted by inflation only when depreciation is charged
  4. DRatios ignore non-financial information entirely

Explanation

Different depreciation methods give different profits and carrying amounts for the same economic position. Return on capital employed and profit margins are therefore not like-for-like. Inflation and non-financial information are separate limitations and are not shown by this scenario.

Did you get it right without looking?

One question tells you little. A timed set on Importance and purpose of analysis of financial statements shows your real accuracy, how long you take and where you lose marks.

Practise Importance and purpose of analysis of financial statementsFree diagnostic mock

More Importance and purpose of analysis of financial statements questions