ExpertMedium2 marksMultiple Choice
ACCA · Question 35 · Interpretation of Financial Statements
Which TWO of the following are valid limitations of using ratio analysis to interpret financial statements?
Which TWO of the following are valid limitations of using ratio analysis to interpret financial statements?
Answer options:
A.
Ratios are based on historical data and may not accurately predict future performance.
B.
Ratios eliminate the effects of inflation, making them perfectly comparable over time.
C.
Different companies may use different accounting policies, making comparison difficult.
D.
Ratios provide a definitive qualitative assessment of management's strategic decisions.
How to approach this question
Identify the inherent weaknesses of financial statements (historical cost, accounting choices) and how they impact ratios.
Full Answer
Ratio analysis has several limitations: 1) It is based on historical data, which may not reflect current or future realities. 2) Companies use different accounting policies (e.g., straight-line vs reducing balance depreciation), which makes comparing their ratios difficult. Ratios do not eliminate inflation, nor do they provide qualitative insights.
Common mistakes
Believing that ratios adjust for inflation or provide qualitative data.
Practice the full ACCA FA — Financial Accounting Practice Exam 3
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