Key Limitations in Ratio Comparisons

Steps:

• Identify common limitations: varying accounting policies (e.g., depreciation), firm size differences, and non-comparable data due to timing.
• Evaluate choices: Assume 1 is differing accounting methods (valid limitation), 2 is size effects (not always a barrier in same industry), 3 is external factors (less direct for ratios).
• Match to correct option: Only limitation 1 strictly applies for invalid comparisons.
• Confirm B selects 1 only, excluding others.

Why B is correct:

• Accounting ratios assume uniform policies; differing methods (e.g., FIFO vs. LIFO) distort comparisons per standard financial analysis principles.

Why the others are wrong:

• A includes 2, but size differences can be adjusted via ratios like ROE.
• C includes 3, but external factors affect all firms similarly in the industry.
• D selects only 3, ignoring the primary policy issue.

Not enough information on exact statements 1–3.

Final answer: B