INTRODUCTION

It is usual, in introductory accounting texts, to have a chapter on the interpretation of accounts. This typically concentrates on the description, detailed definition and computation of various accounting ratios.

The interpretation of accounts is undoubtedly important. Indeed, it is crucial: there is no point in spending resources preparing accounts if we cannot interpret them. Equally, ratios can and do play an important part in the interpretation of accounts. However, just as concentration on the techniques of assembling accounting data can distract attention from restrictive assumptions implicit in the process (such as the historic cost assumption, which we have adopted hitherto but will be questioned in the next chapter), so also can an excessive concentration on the computation of ratios distract attention from some of the fundamental issues in the interpretation of accounts. For this reason, we shall concentrate first on a discussion of fundamental issues followed by a discussion of the principles of ratio analysis and an outline of the broad categories of ratios which are commonly used, rather than their computational details.

The fundamental issues which will be discussed are as follows:

1. (1) Definition of the purpose of interpretation is essential.

2. (2) Accounting data are usually interpreted in the context of other information.

3. (3) Accounts are a system, so that individual accounting ratios can rarely be interpreted independently of others.

4. (4) Accounting data are imperfect, and their interpretation must allow for this.