Accountancy 6 Marks Question

Horizontal analysis: In such type of analysis, financial statements for a number of years are reviewed and analysed. Figures for two or more years are contained in such type of analysis and these figures are placed side-by-side to facilitate comparison. Such analysis indicates the increase or decrease in these itmes not in absolute figures but also in percentage form. Thus, it involves making comparisons and establishing relationship among related items of an enterprise for a number of years. When data about sales, cost of production, profits etc. are compared for two or more years ofa firm, they indicate the areas of strength and weakness of the enterprise. It also helps in knowing the trend of the business. Since such type of analysis is based on the data from year-to-year rather than only one year, it is also called, 'Dynamic Analysis'.

Changes in inventories mence opening stock less closing stock.

Interpretation:

1. Cost of Materials Consumed has increased to 48% in 2018 from 44% in 2017. This is due to reduction in cost of raw materials.
2. Total expenses have decreased to 61% in 2018 from 63% as that in the year 2017 which indicates efficiency on the part of the company. As a result of company's better efficiency, the net profit shows a rise of 3% in the year 2018 (i.e., 43% - 40%).

Comments: The following differences may be observed in the financial position of A Ltd. and B Ltd. on the basis of above common size balance sheet :

1. The short-term financial position of A Ltd. is better as compared to B Ltd. The current liabilities of A Ltd. are 10% of total funds invested whereas a proportion of current assets in these funds is 60%. On the other hand, current liabilities of B Ltd. are 12.5% and current assets 41.67% of these funds. Thus, trade payables are more secured in A Ltd.
2. The long-term financial position is better in B Ltd. because Shareholder's Funds are 60% in case of A Ltd. while it is 66.67% in B Ltd.
3. B Ltd. has invested more (58.33%) in non-current assets as compared to 40% by A Ltd.

Common-Size Financial Statement is a statement in which figures are converted into percentage to a common base, i.e., Revenue from Operations for Common-size Statement of Profit and Loss and Total of Assets or Total of Equity and Liabilities for Common-size Balance Sheet.

1. To present the change in various items in relation to revenue from operations, total assets or total liabilities: One of the major drawbacks of comparative financial statements is that they do not present the change in various items in relation to revenue from operations, total assets or total equity & liabilities. This drawback is removed through the preparation of common size statements.
2. To establish a relationship: Over a period, a relationship is established between various items of the statement of profit & loss to revenue from operations and various items of balance sheet to total assets or total equity & liabilities. Significant conclusions can be drawn by studying the change in-Such a relationship. For example, if over the years it is established that cost of materials consumed constitute 40% of revenue from operations, an increase in this percentage will need immediate attention.

Comparative Financial Statement is a tool of financial analysis that shows change in each item of the Financial Statements in both absolute amount and percentage terms, taking the item in preceding accounting period as base.

1. Data Presentation becomes Simple and Comparable: Comparative Statement or Comparative Financial Statement is a statement with data for two or more years in a tabular form. Thus, it is a simple presentation, understandable and comparable. It helps in drawing conclusions easily.
2. Indicates Trend: Comparative Statement or Comparative Financial Statement gives information about the changes affecting financial position and performance of an enterprise. It is an indicator of trend and, thus, helps in forecasting.
3. Indicates Strengths and Weaknesses: Comparative Statement or Comparative Financial Statement indicates strengths and weaknesses of the enterprise with respect to liquidity, profitability and solvency.
4. Comparison with other Firms and Industry Performance (i.e., Inter-firm Comparison):​​​ Comparative Statement or Comparative Financial Statement helps in comparison of an enterprise's performance with that of other enterprises or with that of the industry.​​​​
5. Forecasting and Planning: Analysing changes and trend in the financial data of previous years helps the management in forecasting and planning.