Example Exercise 3-10 Vertical Analysis Income Statement Balance Sheet Each item is shown as a percent of total assets Each item is shown as a percent of total revenue Vertical analysis is the comparison of each item in a financial statement to a total amount on the statement. It is useful in analyzing relationships in the financial statement. For the balance sheet, [CLICK] each item is shown as a percent of total assets. For the income statement, [CLICK] each item is shown as a percent of total revenue. Vertical analysis is also useful for analyzing changes in the financial statements over time.

Example Exercise 3-10 We will prepare a vertical analysis [CLICK] of Fortson Company’s income statements for 2011 and 2012 in this example exercise.

Example Exercise 3-10 Keep in mind that Fees Earned for Fortson Company is the 100 percent amount. The vertical percentage of operating expenses for 2012 is determined by dividing operating expenses of $263,500 by Fees Earned, of $425,000. This result in an answer of 62 percent [CLICK]. The Operating income percentage is found by dividing $161,500 by $425,000 [CLICK], or 38 percent. Using $375,000 as the 100 percent amount in 2011, we determine that operating expenses are [CLICK] 56 percent of the firm’s revenue. Using the same approach, we determine that operating income [CLICK] is 44 percent of revenue.

Example Exercise 3-10 Does the vertical analysis indicate a favorable or unfavorable trend?

Example Exercise 3-10 (b) Unfavorable! The second step is to determine if the vertical analysis indicates a favorable or unfavorable trend. In this case, revenues have increased; however, operating expenses have also increased as a percentage of revenues thus creating a decrease in operating income which is an UNFAVORABLE [CLICK] trend. (b) Unfavorable!

Example Exercise 3-10  For Practice: PE 3-10A, PE 3-10B Refer to Practice Exercise PE 3-10A and PE 3-10B for accounts requiring adjustment.  For Practice: PE 3-10A, PE 3-10B