You are in the process of analyzing two similar companies in the same industry. You learn that they have different accounting practices and policies, as follows:
1. Company A, which has the same type of equipment as Company B, uses the straight-line method of depreciation while Company B uses diminishing-balance. This is the first year of operations for both companies.
2. Company A is a private company and does not report other comprehensive income. Company B is a publicly traded company that generates and reports other comprehensive income from the revaluation of property, plant, and equipment.
Instructions
(a) Considering only the impact of the choice of depreciation method, determine which company will report a higher
(1) Current ratio,
(2) Debt to total assets ratio, and
(3) Profit margin ratio, or if the depreciation method will have no impact.
(b) Considering only the impact of total comprehensive income, determine which company will report a higher
(1) Current ratio,
(2) Debt to total assets ratio, and
(3) Profit margin ratio, or if the other comprehensive income will have no impact.
(c) Will the use of different accounting practices and policies affect your analysis? Explain.
(d) Identify two other limitations of financial analysis that an analyst should watch for when analyzing financial statements.