Financial Accounting: Liabilities & Equities (FA3) Exam Review

FA3 Exam Review notes Barbara Wyntjes, CGA, MBA, B.Sc.
Question 2
Kerri Martinsky, CEO of Polly Inc., has asked you, assistant controller, to compare the
operations and financial position of Polly to those of its closest competitor, Plastic Ltd.
Polly and Plastic are similar in size and overall business operations. The following
information has been compiled for your review, based on the most recent financial
statements:
Common Size Income Statements
Polly Inc. Plastic Ltd.
2007 2006 2007 2006
Sales $100.0 100 % $ 100 100%
Cost of sales 72.0 70 68 70
Gross margin 28.0 30 32 30
Expenses 20.5 25 23 24
Net income $ 7.5 5 % $ 9 6 %
Increase in sales over 2006 30% 20%
Polly Inc. Plastic Ltd.
2007 2006 2007 2006
Current ratio 2.05 1.80 1.57 2.16
Quick ratio 0.87 0.53 0.42 0.66
Accounts receivable turnover 20.00 16.67 11.61 10.00
Inventory turnover 4.45 3.68 2.89 2.87
Long-term debt to equity 0.08 0.17 0.47 0.58
Return on total assets (ROA) 17.70 10.00 12.60 7.60
Return on equity 28.90 16.00 26.20 15.20
Investing activities
Purchase of capital assets $10,000 $40,000 $250,000 $400,000
You notice from the notes to the financial statements that both companies use similar
accounting policies.
Required
7 a. Write a memo to Kerri that compares and contrasts Polly to Plastic in terms of:
i) Liquidity, indicating which ratios you used in your analysis and which areas Kerri
should be concerned with
ii) Profitability, indicating which ratios you used in your analysis and which areas Kerri
should be concerned with
1 b. Indicate why Plastic’s long-term debt-to-equity ratio might be higher than Polly’s.
2