Which of the following statements best describes vertical common-size analysis and horizontal common-size analysis?
Statement #1 – Each line item is expressed as a percentage of its base-year amount.
Statement #2 – Each line item of the income statement is expressed as a percentage of revenue and each line item of the balance sheet is expressed as a percentage of ending total assets.
Statement #3 – Each line item is expressed as a percentage of the prior year’s amount.
| Vertical analysis | Horizontal analysis |
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Horizontal common-size analysis involves expressing each line item as a percentage of the base-year figure. Vertical common-size analysis involves expressing each line item of the income statement as a percentage of revenue and each line item of the balance sheet as a percentage of ending total assets.
Are the following statements about common-size financial statements correct or incorrect?
Statement #1 – Expressing financial information in a common-size format enables the analyst to make better comparisons between two firms of similar size that operate in different industries.
Statement #2 – Common-size financial statements can be used to highlight the structural changes in the firm’s operating results and financial condition that have occurred over time.
With respect to these statements:
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Vertical common-size statements enable the analyst to make better comparisons of two firms of different sizes that operate in the same industry. Horizontal common-size financial statements express each line as a percentage of the base year figure; thus, horizontal common-size statements can be used to identify structural changes in a firm’s operating results and financial condition over time.
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