Question

Answer each of the following related to international accounting and analysis.

a. Identify a limitation to using ratio analysis when examining companies reporting under different accounting systems such as IFRS versus U.S. GAAP.

b. Identify an advantage to using horizontal and vertical analyses when examining companies reporting under different currencies.

Short answer

a. Ratio analysis proves to be disadvantageous when comparing business entities of different sizes. It also does not consider the qualitative aspects, inflation rate, and contingent liabilities.

b. It helps the management and external users compare the business entity’s position in the previous year with the current year.

Step-by-step solution

Definition of Financial Ratios

Financial ratioscan compare the various line items of the financial statement. These ratios depict the financial position by providing information about liquidity, solvency, and profitability.

Limitation of using ratio analysis

1. Ratio analysis does not consider the size of the business entity.
2. Ratio analysis does not consider the contingent liability reported by the business entity.
3. Ratio analysis is based on historical data.
4. Ratio analysis does not consider the inflation prevailing in the economy.

Advantages of using horizontal and vertical analysis

1. Vertical analysis provides a correlation between each item reported on the financial items and the selected base item. The business entity can use this correlation to establish goals and set limits.
2. Horizontal analysis helps identify trends in the various line items of the financial statements. It also helps the business entity in projecting future trends. It allows us to compare the present position of the business entity with the past situation.