State the different accounting policies
Different accounting policies which can be adopted will have an influence on the ratios calculated and hence make comparisons more difficult. Different accounting policies affect the income statement and statement of financial position and these impacts on all the major ratios like gearing and ROCE.
1 Noncurrent assets can be valued using revaluation model or cost model. This will have an impact on statement of financial position and income statement, with lower or higher depreciation charges.
2 Capitalisation of borrowing costs is optional, resulting in statement of financial position and income statement being affected. Capitalisation reports higher profits (as less interest expense) and higher capital employed (high noncurrent assets).
3 Inventory valuation at the yearend would result in higher or lower cost of sales and thus different profit figures. FIFO and weighted average method are allowed.
4 Finance leases are capitalised with the obligation being set up as well. This will have an impact on both ROCE andgearing. Operating leases aren't capitalised.
5 Defined benefit pension plan has different methods of dealing with actuarial gains and losses which go through income statement and thus affect profitability.
6 Goodwill on acquisition used to be amortised through income statement. It isn't now and only impairment losses go through income statement. This will make profitability more volatile. Statement of financial position will show goodwill indefinitely and thus ROCE will be lower.
7 International company comparisons adds another layer of problems, where different accounting policies are used.