Question

Which one of the following statements is correct?

a) Define and explain the concept of peer group analysis in the context of financial evaluation and comparison.
b) Instruct the respondent to evaluate the provided statement—'Peer group analysis is simplified when firms use varying methods of depreciation.'
c) Encourage a brief explanation or justification for the chosen answer, demonstrating an understanding of the factors influencing the complexity or simplicity of peer group analysis.

Ensure clarity in the question to prompt a thoughtful assessment of the statement's correctness in the context of peer group analysis and depreciation methods.

Answer 1

The statement is incorrect; peer group analysis is not simplified by varying depreciation methods as they introduce complexities in financial comparison, requiring adjustments for proper evaluation.

Step-by-step explanation:

The statement that peer group analysis is simplified when firms use varying methods of depreciation is not accurate. Peer group analysis involves comparing a company to a set of similar companies (its peers) to evaluate performance, strategies, and potential areas for improvement. However, when firms within a peer group use different methods of depreciation such as straight-line, reducing balance, or units of production, it can complicate comparisons.

The reason for this complexity is that different depreciation methods can result in different expense amounts and timings, affecting profitability and asset values on the balance sheet. To accurately evaluate and compare firm performance, analysts must adjust financial statements to ensure consistency in accounting practices. Without such adjustments, it would be challenging to isolate the operational performance from accounting differences.