Choosing the Base Year
Chapter Fifteen
Syllabus topic 2, "Trend Analysis – Concept, selection of base year, computation of trend percentages and interpretation of trends in sales, profits, assets, liabilities and shareholders’ funds."
Pages 36 to 38 of 162
In one line
The base year must be a normal year, near the start of the run, on the same accounting policies as the rest, and with no figure that is nil or negative.
The four tests
| Test | Why | |
|---|---|---|
| 1 | It must be a NORMAL year | Every later percentage is measured against it, so an abnormal base makes the whole run misleading |
| 2 | It should be at or near the START of the period | So that the run reads forward and the direction is visible |
| 3 | The accounting policies must be the same as the later years' | Or the run crosses a break and the movement is partly a change of method |
| 4 | No item in it may be nil or negative | Because no index can be computed on such a base |
What makes a year abnormal
Any of these disqualifies a year as a base, and a question that mentions one is telling you to choose a different year.
- A strike, a lock-out or a shutdown, which depresses sales and profit.
- A fire, a flood or another calamity.
- A boom year, when demand was exceptional and will not repeat.
- The first year of trading, which is never typical.
- A year with a large one-off item: the sale of a division, a compensation receipt, a heavy write-off.
- A year in which the accounting policy changed, or the company amalgamated with or acquired another.
The test is not "was it a good year". It is "was it a typical year". An unusually good year is as bad a base as an unusually bad one.
What a bad base does: worked
A company's sales were depressed in 2023 by a four-month strike. The five years are:
| Year | Sales, Rs |
|---|---|
| 2023 | 6,00,000 |
| 2024 | 12,00,000 |
| 2025 | 13,20,000 |
| 2026 | 14,40,000 |
| 2027 | 15,00,000 |
On the strike year as base, 2023 = 100.
| Year | Trend |
|---|---|
| 2023 | 100 |
| 2024 | 200 |
| 2025 | 220 |
| 2026 | 240 |
| 2027 | 250 |
On the first normal year as base, 2024 = 100.
| Year | Trend |
|---|---|
| 2024 | 100 |
| 2025 | 110 |
| 2026 | 120 |
| 2027 | 125 |
The same company, and two different stories. The first table says sales have more than doubled and the business is growing spectacularly. The second says sales have grown 25 per cent in three years, steadily and modestly. The second is the truth, and the first is an artefact of measuring everything against a year in which the factory was shut.
Notice also that the first table's growth appears to be slowing while the second's is roughly steady, so the bad base has corrupted the reading of the acceleration as well as of the level.
What to do when no year is normal
Three ways out, in order of preference.
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