Factors affecting quality of earnings; Prepare a flexible budget; Understating and manipulating sales forecasts; SFAC No. 13; Lease classifications

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Financial statements include income statement, balance sheet and cash flow statement. The analysis of financial statements will help the investors to infer about the financial health of the company in terms of profitability, liquidity and solvency of the company. The tools of financial analysis are ratio analysis, horizontal analysis, vertical analysis, trend analysis.

For the purpose of analysis of financial statements, the financial statements of two companies should be in the comparable nature. That is two companies should be from the same industry. That is it is incorrect to compare the financial statement of company in automobile industry with the company in the hotel industry. The financial statements of two companies should be compared for the same period. While analyzing the financial statements, it should be insured that the accounting policies are being consistently followed. If there is any change in any year, then that change should be given due consideration while evaluating the financial statements. The financial statements should be compared with the historical data or financial statements of competitors or with the industry average.

Limitations of financial statement analysis:

1. Financial analysis of two companies can be done only if the accounting policies of two companies are same. For example, one company may use written down value method for a particular asset and another company may use straight line method of depreciation for the same type of asset. Therefore, comparison of financial statements without considering the fact will lead to wrong conclusions.
2. The inference from the results of ratio analysis cannot be taken from the mere ratios. The interpretation of the ratios should be done after taking into account the various factors constituting the same. The results should be analyzed after considering the notes to the financial statements.
3. Financial statements are prepared on cost principle. Therefore, inflationary effects are not considered while preparing the financial statements and therefore conclusions drawn from the financial statements will be misleading.

ANSWER TO QUESTION NO 23.12:

William George . the marketing manager of the company has underestimated the sales forecast in such a way that actual sales exceed the sales forecast. Therefore, William ...