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Chapter 24: Question 27Q (page 1446)

Explain the meaning of the following terms: (a) common size analysis, (b) vertical analysis, (c) horizontal analysis, and (d) percentage analysis.

Short Answer

Expert verified

At all times, horizontal analysis is performed horizontally, while vertical analysis is performed vertically inside the column. Percentages are used to compare data between two or more systems, while directors of finance use common-size analysis.

Step by step solution

01

Meaning of Common Size Analysis

The common size analysis is to divide all dollar amounts in financial statements by a percentage of the base amount.

02

Meaning of Vertical Analysis

Vertical analysis is the percentage-wise expression of the base number of each item on the financial statement over a specific time period.

03

Meaning of Horizontal Analysis

Horizontal analysis is a calculation of the rate change over time. This is usually shown as a percentage increase compared to the same line item in the previous year. Users of financial statements can quickly view trends and development designs using horizontal analysis.

04

Meaning of Percentage Analysis

Percentage analysis is condensing a set of linked quantities into a range of rates on a specific basis. This form of check encourages comparison and is useful for valuing items such as cost, current assets, or net income.

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Most popular questions from this chapter

Olga Conrad, a financial writer, noted recently, โ€œThere are substantial arguments for including earnings projections in annual reports and the like. The most compelling is that it would give anyone interested something now available to only a relatively select fewโ€”like large stockholders, creditors, and attentive bartenders.โ€ Identify some arguments against providing earnings projections.

The following information was described in a note of Canon Packing Co.

โ€œDuring August, Holland Products Corporation purchased 311,003 shares of the Companyโ€™s common stock which constitutes approximately 35% of the stock outstanding. Holland has since obtained representation on the Board of Directors.โ€

โ€œAn affiliate of Holland Products Corporation acts as a food broker for Canon Packing in the greater New York City marketing area. The commissions for such services after August amounted to approximately $20,000.โ€

Why is this information disclosed?

(Dividend Policy Analysis) Matheny Inc. went public 3 years ago. The board of directors will be meeting shortly after the end of the year to decide on a dividend policy. In the past, growth has been financed primarily through the retention of earnings. A stock or a cash dividend has never been declared. Presented below is a brief financial summary of Matheny Inc.โ€™s operations.

(\(000 omitted)

2018

2017

2016

2015

2014

Sales revenue

\)20,000

\(16,000

\)14,000

\(6,000

\)4,000

Net income

2,400

14,000

800

700

250

Average total assets

22,000

19,000

11,500

4,200

3,000

Current assets

8,000

6,000

3,000

1,200

1,000

Working capital

3,600

3,200

1,200

500

400

Common shares:

Number of shares

Outstanding (000)

Average market price

2,000

\(9

2,000

\)6

2,000

$4

20

-

20

-

Instructions

  1. Comment on the appropriateness of declaring a cash dividend at this time, using the ratios computed in part (b) as a major factor in your analysis.

The following statement is an excerpt from the FASB pronouncement related to interim reporting. Interim financial information is essential to provide investors and others with timely information as to the progress of the enterprise. The usefulness of such information rests on the relationship that it has to the annual results of operations. Accordingly, the Board has concluded that each interim period should be viewed primarily as an integral part of an annual period. In general, the results for each interim period should be based on the accounting principles and practices used by an enterprise in the preparation of its latest annual financial statements unless a change in an accounting practice or policy has been adopted in the current year. The Board has concluded, however, that certain accounting principles and practices followed for annual reporting purposes may require modification at interim reporting dates so that the reported results for the interim period may better relate to the results of operations for the annual period.

Instructions

The following six independent cases present how accounting facts might be reported on an individual companyโ€™s interim financial reports. For each of these cases, state whether the method proposed to be used for interim reporting would be acceptable under generally accepted accounting principles applicable to interim financial data. Support each answer with a brief explanation.

f) LaBrava Company was reasonably certain it would have an employee strike in the third quarter. As a result, it shipped heavily during the second quarter but plans to defer the recognition of the sales in excess of the normal sales volume. The deferred sales will be recognized as sales in the third quarter when the strike is in progress. LaBrava Company management thinks this is more representative of normal second- and third-quarter operations.

(Disclosure of Estimates) Nancy Tercek, the financial vice president, and Margaret Lilly, the controller, of Romine Manufacturing Company are reviewing the financial ratios of the company for the years 2017 and 2018. The financial vice president notes that the profit margin on sales ratio has increased from 6% to 12%, a hefty gain for the 2-year period. Tercek is in the process of issuing a media release that emphasizes the efficiency of Romine Manufacturing in controlling cost. Margaret Lilly knows that the difference in ratios is due primarily to an earlier company decision to reduce the estimates of warranty and bad debt expense for 2018. The controller, not sure of her supervisorโ€™s motives, hesitates to suggest to Tercek that the companyโ€™s improvement is unrelated to efficiency in controlling cost. To complicate matters, the media release is scheduled in a few days.

Instructions

  1. What stakeholders might be affected by Tercekโ€™s media release?
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