Financial Accounting: Liabilities & Equities (FA3) Exam Review

FA3 Exam Review notes Barbara Wyntjes, CGA, MBA, B.Sc.
Solution:
a. (7 marks)
To: Kerri Martinsky, CEO
From: Zhang Chen, Assistant Controller
Date: June 12, 2008
Re: Ratio comparison with Plastic Ltd.
(1) i) From a liquidity view, Polly appears to be quite liquid in 2007, compared with
Plastic (quick ratio).
(1) The receivables turnover and inventory turnover are significantly better than Plastic’s,
indicating good management over this area.
(1) This results in Polly having an overall better liquidity position than Plastic. There
appears to be no concerns in this area; however, this is not to say improvements could not
be made.
(1) ii) From a profitability view, the return on assets and equity is very good, indicating
that Polly is a well-managed and profitable business.
(1) However, it should also be noted that Plastic is increasing its fixed assets and longterm
debt, while Polly is not. Depending on the nature of these capital asset (for example,
improved efficiency), this could cause concern in the future.
(1) Also, Polly’s ROA is higher because it has a smaller asset base as a result of not
investing in capital assets as much as Plastic has in the past 2 years.
(1) We should investigate the decline of Polly’s gross margin, and attempt to reverse this
trend. We should also reconsider Polly’s capital asset financing policy. The company has
the capacity for additional long-term debt, which would provide leverage to further
improve return on equity, and potential strategic advantages if invested in the correct
assets.
Note:
3 marks for liquidity discussion; 3 marks for profitability discussion; 1 mark for areas of
concern (lack of capital asset investment or gross margin decline)
b. (1 mark)
Plastic’s long-term debt is higher than Polly’s because Plastic is likely financing the
purchase of capital assets with debt.
3