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 inventory as Company B, uses the FIFO cost method while Company B uses average. Prices have generally been rising in this industry.

2. Company A uses the double-diminishing balance depreciation method for most of its buildings, while Company B uses the straight-line method for its buildings.

Instructions

(a) Considering only the impact of the choice of inventory cost method, determine which company will report a higher

(1) Current ratio,

(2) Debt to total assets ratio, and

(3) Profit margin ratio, or whether the choice of cost method will have no impact This is the first year of operations for both companies.

(b) 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 whether the choice of depreciation method will have no impact. This is the first year of operations for both companies.

(c) Will the use of different accounting estimates and policies affect your analysis? Explain.

(d) Identify two other limitations of financial analysis that an analyst should watch for when analyzing financial statements.