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CHAPTER 15
FINANCIAL STATEMENT ANALYSIS
CHAPTER LEARNING OBJECTIVES
1. Apply horizontal analysis and vertical analysis to financial statements. There are three
bases of comparison: (1) Intracompany, which compares an item or financial relationship with
other data within a company. (2) Industry, which compares company data with industry
averages. (3) Intercompany, which compares an item or financial relationship of a company
with data of one or more competing companies.
Horizontal analysis is a technique for evaluating a series of data over a period of time to
determine the increase or decrease that has taken place, expressed as either an amount or a
percentage.
Vertical analysis is a technique that expresses each item within a financial statement in terms
of a percentage of a relevant total or a base amount.
2. Analyze a company’s performance using ratio analysis. The formula and purpose of each
ratio is presented in Illustration 15–26.
3. Apply the concept of sustainable income. Sustainable income analysis is useful in
evaluating a company’s performance. Sustainable income is the most likely level of income to
be obtained by the company in the future. Discontinued operations and other comprehensive
income are presented on the statement of comprehensive income to highlight their unusual
nature.Items below income from continuing operations must be presented net of tax.
TRUE-FALSE STATEMENTS
1. Intracompany comparisons of the same financial statement items can often detect
changes in financial relationships and significant trends.
Ans: T, LO: 1, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Performance
Measurement
2. Calculating financial ratios is a financial reporting requirement under IFRS.
Ans: F, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Performance
Measurement
3. Measures of a company's liquidity are concerned with the frequency and amounts of
dividend payments.
Ans: F, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Performance
Measurement
4. Analysis of financial statements is enhanced with the use of comparative data.
Ans: T, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Performance
Measurement
5. Comparisons of company data with industry averages can provide some insight into the
company's relative position in the industry.
Ans: T, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Industry/Sector, AICPA FN: Reporting, AICPA PC: None, IMA: Performance
Measurement
6. Vertical and horizontal analyses are concerned with the format used to prepare financial
statements.
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15 - 2 Test Bank for Financial Accounting: IFRS Edition, 4e
Ans: F, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Reporting
7. Horizontal, vertical, and circular analyses are the most common tools of financial
statement analysis.
Ans: F, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Reporting
8. Horizontal analysis is a technique for evaluating a financial statement item in the current
year compared to other items in the current year.
Ans: F, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Performance
Measurement
9. Another name for trend analysis is horizontal analysis.
Ans: T, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Performance
Measurement
10. If a company has sales revenue of $110 in 2019 and $154 in 2020, the percentage
increase in sales revenue from 2019 to 2020 is 140%.
Ans: F, LO: 1, Bloom: AP, Difficulty: Easy, Min: 1, AACSB: Analytic, AICPA BB: None, AICPA FN: Measurement, AICPA PC: Problem Solving, IMA:
Performance Measurement
11. In horizontal analysis, if an item has a negative amount in the base year, and a positive
amount in the following year, no percentage change for that item can be computed.
Ans: T, LO: 1, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Performance
Measurement
12. Common size analysis expresses each item within a financial statement in terms of a
percent of a base amount.
Ans: T, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Performance
Measurement
13. Vertical analysis is a more sophisticated analytical tool than horizontal analysis.
Ans: F, LO: 1, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Performance
Measurement
14. Vertical analysis is useful in making comparisons of companies of different sizes.
Ans: T, LO: 1, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Performance
Measurement
15. Meaningful analysis of financial statements will include either horizontal or vertical
analysis, but not both.
Ans: F, LO: 1, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Performance
Measurement
16. Using vertical analysis of the income statement, a company's net income as a percentage
of net sales is 10%; therefore, the cost of goods sold as a percentage of net sales must be
90%.
Ans: F, LO: 1, Bloom: C, Difficulty: Easy, Min: 1, AACSB: Analytic, AICPA BB: None, AICPA FN: Measurement, AICPA PC: Problem Solving, IMA:
Performance Measurement
17. In the vertical analysis of the income statement, each item is generally stated as a
percentage of net income.
Ans: F, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Performance
Measurement
18. A ratio can be expressed as a percentage, a rate, or a proportion.
Ans: T, LO: 2, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Performance
Measurement
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Financial Statement Analysis 15 - 3
19. A solvency ratio measures the income or operating success of an enterprise for a given
period of time.
Ans: F, LO: 2, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Performance
Measurement
20. The current ratio is a measure of all the ratios calculated for the current year.
Ans: F, LO: 2, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Performance
Measurement
21. Inventory turnover measures the number of times on average the inventory was sold
during the period.
Ans: T, LO: 2, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Performance
Measurement
22. Profitability ratios are frequently used as a basis for evaluating management's operating
effectiveness.
Ans: T, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Performance
Measurement
23. The return on total assets will be greater than the return on ordinary shareholders' equity if
the company has been successful in trading on the equity at a gain.
Ans: F, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Performance
Measurement
24. From a creditor's point of view, the higher the debt to total assets ratio, the lower the risk
that the company may be unable to pay its obligations.
Ans: F, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Risk Analysis, AICPA PC: None, IMA: Investment Decisions
25. A current ratio of 1.2 to 1 indicates that a company's current assets exceed its current
liabilities.
Ans: T, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: Analytic, AICPA BB: None, AICPA FN: Measurement, AICPA PC: Problem Solving, IMA:
Performance Measurement
26. Using borrowed money to increase the return on ordinary shareholders' equity is called
"trading on the equity."
Ans: T, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Business Economics
27. When the disposal of a significant component occurs, the income statement should report
both income from continuing operations and income (loss) from discontinued operations.
Ans: T, LO: 3, Bloom: K, Difficulty: Easy, Min: 1, AACSB: Communications, AICPA BB: Legal/Regulatory, AICPA FN: Reporting, AICPA PC: None, IMA:
Reporting
28. Companies report most changes in accounting principle under other income and expense.
Ans: F, LO: 3, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Legal/Regulatory, AICPA FN: Reporting, AICPA PC: None, IMA: Reporting
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15 - 4 Test Bank for Financial Accounting: IFRS Edition, 4e
29. Comprehensive income includes all changes in equity during a period except those
resulting from investments by shareholders and distributions to shareholders.
Ans: T, LO: 3, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Legal/Regulatory, AICPA FN: Reporting, AICPA PC: None, IMA: Reporting
30. Other comprehensive income is not included in net income and is recorded as a direct
adjustment to equity.
Ans: T, LO: 3, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Legal/Regulatory, AICPA FN: Reporting, AICPA PC: None, IMA: Reporting
31. The three basic tools of analysis are horizontal analysis, vertical analysis, and ratio
analysis.
Ans: T, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: Analytic, AICPA BB: Legal/Regulatory, AICPA FN: Reporting, AICPA PC: None, IMA: Reporting
32. A percentage change can be computed only if the base amount is zero or positive.
Ans: F, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Legal/Regulatory, AICPA FN: Reporting, AICPA PC: None, IMA: Reporting
33. In vertical analysis, the base amount in an income statement is usually net sales.
Ans: T, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Legal/Regulatory, AICPA FN: Reporting, AICPA PC: None, IMA: Reporting
34. Profitability ratios measure the ability of the enterprise to survive over a long period of
time.
Ans: F, LO: 2, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Legal/Regulatory, AICPA FN: Reporting, AICPA PC: None, IMA: Reporting
35. The days in inventory is computed by multiplying inventory turnover by 365.
Ans: F, LO: 2, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Legal/Regulatory, AICPA FN: Reporting, AICPA PC: None, IMA: Reporting
36. The presentation of the accumulated other comprehensive loss is similar to the
presentation of the cost of treasury shares in the equity section.
Ans: T, LO: 3, Bloom: K, Difficulty: Easy, Min: 1, AACSB: Communications, AICPA BB: Legal/Regulatory, AICPA FN: Reporting, AICPA PC: None, IMA:
Reporting
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CHAPTER 15
FINANCIAL STATEMENT ANALYSIS
CHAPTER LEARNING OBJECTIVES
1. Apply horizontal analysis and vertical analysis to financial statements. There are three
bases of comparison: (1) Intracompany, which compares an item or financial relationship with
other data within a company. (2) Industry, which compares company data with industry
averages. (3) Intercompany, which compares an item or financial relationship of a company
with data of one or more competing companies.
Horizontal analysis is a technique for evaluating a series of data over a period of time to
determine the increase or decrease that has taken place, expressed as either an amount or a
percentage.
Vertical analysis is a technique that expresses each item within a financial statement in terms
of a percentage of a relevant total or a base amount.
2. Analyze a company’s performance using ratio analysis. The formula and purpose of each
ratio is presented in Illustration 15–26.
3. Apply the concept of sustainable income. Sustainable income analysis is useful in
evaluating a company’s performance. Sustainable income is the most likely level of income to
be obtained by the company in the future. Discontinued operations and other comprehensive
income are presented on the statement of comprehensive income to highlight their unusual
nature.Items below income from continuing operations must be presented net of tax.
TRUE-FALSE STATEMENTS
1. Intracompany comparisons of the same financial statement items can often detect
changes in financial relationships and significant trends.
Ans: T, LO: 1, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Performance
Measurement
2. Calculating financial ratios is a financial reporting requirement under IFRS.
Ans: F, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Performance
Measurement
3. Measures of a company's liquidity are concerned with the frequency and amounts of
dividend payments.
Ans: F, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Performance
Measurement
4. Analysis of financial statements is enhanced with the use of comparative data.
Ans: T, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Performance
Measurement
5. Comparisons of company data with industry averages can provide some insight into the
company's relative position in the industry.
Ans: T, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Industry/Sector, AICPA FN: Reporting, AICPA PC: None, IMA: Performance
Measurement
6. Vertical and horizontal analyses are concerned with the format used to prepare financial
statements.
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15 - 2 Test Bank for Financial Accounting: IFRS Edition, 4e
Ans: F, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Reporting
7. Horizontal, vertical, and circular analyses are the most common tools of financial
statement analysis.
Ans: F, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Reporting
8. Horizontal analysis is a technique for evaluating a financial statement item in the current
year compared to other items in the current year.
Ans: F, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Performance
Measurement
9. Another name for trend analysis is horizontal analysis.
Ans: T, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Performance
Measurement
10. If a company has sales revenue of $110 in 2019 and $154 in 2020, the percentage
increase in sales revenue from 2019 to 2020 is 140%.
Ans: F, LO: 1, Bloom: AP, Difficulty: Easy, Min: 1, AACSB: Analytic, AICPA BB: None, AICPA FN: Measurement, AICPA PC: Problem Solving, IMA:
Performance Measurement
11. In horizontal analysis, if an item has a negative amount in the base year, and a positive
amount in the following year, no percentage change for that item can be computed.
Ans: T, LO: 1, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Performance
Measurement
12. Common size analysis expresses each item within a financial statement in terms of a
percent of a base amount.
Ans: T, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Performance
Measurement
13. Vertical analysis is a more sophisticated analytical tool than horizontal analysis.
Ans: F, LO: 1, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Performance
Measurement
14. Vertical analysis is useful in making comparisons of companies of different sizes.
Ans: T, LO: 1, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Performance
Measurement
15. Meaningful analysis of financial statements will include either horizontal or vertical
analysis, but not both.
Ans: F, LO: 1, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Performance
Measurement
16. Using vertical analysis of the income statement, a company's net income as a percentage
of net sales is 10%; therefore, the cost of goods sold as a percentage of net sales must be
90%.
Ans: F, LO: 1, Bloom: C, Difficulty: Easy, Min: 1, AACSB: Analytic, AICPA BB: None, AICPA FN: Measurement, AICPA PC: Problem Solving, IMA:
Performance Measurement
17. In the vertical analysis of the income statement, each item is generally stated as a
percentage of net income.
Ans: F, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Performance
Measurement
18. A ratio can be expressed as a percentage, a rate, or a proportion.
Ans: T, LO: 2, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Performance
Measurement
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Financial Statement Analysis 15 - 3
19. A solvency ratio measures the income or operating success of an enterprise for a given
period of time.
Ans: F, LO: 2, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Performance
Measurement
20. The current ratio is a measure of all the ratios calculated for the current year.
Ans: F, LO: 2, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Performance
Measurement
21. Inventory turnover measures the number of times on average the inventory was sold
during the period.
Ans: T, LO: 2, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Performance
Measurement
22. Profitability ratios are frequently used as a basis for evaluating management's operating
effectiveness.
Ans: T, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Performance
Measurement
23. The return on total assets will be greater than the return on ordinary shareholders' equity if
the company has been successful in trading on the equity at a gain.
Ans: F, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Performance
Measurement
24. From a creditor's point of view, the higher the debt to total assets ratio, the lower the risk
that the company may be unable to pay its obligations.
Ans: F, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Risk Analysis, AICPA PC: None, IMA: Investment Decisions
25. A current ratio of 1.2 to 1 indicates that a company's current assets exceed its current
liabilities.
Ans: T, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: Analytic, AICPA BB: None, AICPA FN: Measurement, AICPA PC: Problem Solving, IMA:
Performance Measurement
26. Using borrowed money to increase the return on ordinary shareholders' equity is called
"trading on the equity."
Ans: T, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: None, AICPA FN: Reporting, AICPA PC: None, IMA: Business Economics
27. When the disposal of a significant component occurs, the income statement should report
both income from continuing operations and income (loss) from discontinued operations.
Ans: T, LO: 3, Bloom: K, Difficulty: Easy, Min: 1, AACSB: Communications, AICPA BB: Legal/Regulatory, AICPA FN: Reporting, AICPA PC: None, IMA:
Reporting
28. Companies report most changes in accounting principle under other income and expense.
Ans: F, LO: 3, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Legal/Regulatory, AICPA FN: Reporting, AICPA PC: None, IMA: Reporting
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15 - 4 Test Bank for Financial Accounting: IFRS Edition, 4e
29. Comprehensive income includes all changes in equity during a period except those
resulting from investments by shareholders and distributions to shareholders.
Ans: T, LO: 3, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Legal/Regulatory, AICPA FN: Reporting, AICPA PC: None, IMA: Reporting
30. Other comprehensive income is not included in net income and is recorded as a direct
adjustment to equity.
Ans: T, LO: 3, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Legal/Regulatory, AICPA FN: Reporting, AICPA PC: None, IMA: Reporting
31. The three basic tools of analysis are horizontal analysis, vertical analysis, and ratio
analysis.
Ans: T, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: Analytic, AICPA BB: Legal/Regulatory, AICPA FN: Reporting, AICPA PC: None, IMA: Reporting
32. A percentage change can be computed only if the base amount is zero or positive.
Ans: F, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Legal/Regulatory, AICPA FN: Reporting, AICPA PC: None, IMA: Reporting
33. In vertical analysis, the base amount in an income statement is usually net sales.
Ans: T, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Legal/Regulatory, AICPA FN: Reporting, AICPA PC: None, IMA: Reporting
34. Profitability ratios measure the ability of the enterprise to survive over a long period of
time.
Ans: F, LO: 2, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Legal/Regulatory, AICPA FN: Reporting, AICPA PC: None, IMA: Reporting
35. The days in inventory is computed by multiplying inventory turnover by 365.
Ans: F, LO: 2, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Legal/Regulatory, AICPA FN: Reporting, AICPA PC: None, IMA: Reporting
36. The presentation of the accumulated other comprehensive loss is similar to the
presentation of the cost of treasury shares in the equity section.
Ans: T, LO: 3, Bloom: K, Difficulty: Easy, Min: 1, AACSB: Communications, AICPA BB: Legal/Regulatory, AICPA FN: Reporting, AICPA PC: None, IMA:
Reporting
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