\ FINANCIAL STATEMENT ANALYSIS TWO METHODS OF FORMING HORIZONTAL OR

COMPARATIVE ANALYSIS
NATURE OF FINANCIAL STATEMENT ANALYSIS
1. Absolute Amount Comparison
Financial statement analysis is the process of ➢ The absolute amount of each item
selecting related data from financial statements to appearing in the financial statements is
evaluate the entity's past financial position and determined by deducting the amount of
operating performance and predict the outcome of the previous year, also designated as the
future operations. The information provided in the base amount of the base year, from the
financial statements, along with other information in amount of current date financial
the notes, assists users in predicting the entity's statements. This method will identify the
future financial performance, including their timing items that are changing the most.
and certainty. The basic objective of financial 2. Percentage Comparison
statement analysis is to assist the different users in ➢ The second method of comparison works
their decision-making process. on the percentage of change which is
determined by dividing the absolute
amount of change by the base figure. This
Some of the more important information method will identify the items that are
provided by financial statements focus on the changing the most. The second method of
following areas: comparison works on the percentage of
change which is determined by dividing
1. up-to-date status of the entity's financial the absolute amount of change by the base
position amount.
2. up-to-date status of the entity's financial
operations
3. up-to-date status of the entity's cash flows
Guidelines that should be observed in horizontal
4. up-to-date general picture of the entity's
analysis:
management of resources
1. Present the current year and previous year's
financial statements in comparative format
The following procedures may be adopted in 2. Compute the absolute amount of change or
analyzing financial statements: difference. The difference could be either an
increase or a decrease.
1. Establish the objective of the financial 3. Express the difference in percentage by
statement analysis. dividing the amount of change by the
2. Gather complete information about the firm and baseamount.
study the industry in which the firm operates. 4. The computation of percentage of change will
3. Perform mathematical analysis using applicable not apply if the base amount is negative or
tools. zero.
4. Make conclusions relative to the established 5. Interpret the change of an item by relating with
objectives. the change or movement of other related items.

METHODS OF ANALYZING FINANCIAL VERTICAL OR COMMON-SIZE APPROACH

STATEMENTS
- The vertical or common-size approach is an
HORIZONTAL OR COMPARATIVE ANALYSIS analytical tool that determines the size or
proportion of an item in the financial statements
- Horizontal or comparative approach is an in relation to a determined total, depending on
analytical tool that evaluates the present which financial statement is being analyzed.
performance of an entity compared to last The accounting period involved in this process
year's. The analysis reflects the differences in is a single period only.
absolute amount and in percentage between - Vertical or common-size analysis becomes
two periods only, namely, the present year and more valuable if the common-size financial
the previous year. The primary objective of statements of an entity are compared with the
horizontal or comparative analysis is to statements of other entities in the industry. The
determine the present status of the business in results of this analysis assist the management
terms of financial position, result of operation, and other interested users in making economic
and cash flows against last year's only. decisions involving proper allocation and
utilization of resources
- Vertical analysis is also a tool that determines of an entity. Normally, the base year is the
whether the business is operating according to earliest year used in the analysis and has an
its nature. It is expected that the business will EER, index of 100 or 100%.
allocate more funds to the accounting elements 3. Divide each absolute amount by the base year,
that contribute more to its profitability, liquidity, and multiply the result by 100 to express the
and solvency data in percentage.

Guidelines that should be observed in vertical HORIZONTAL OR COMPARATIVE ANALYSIS

analysis:

1. Convert the absolute peso amount of the items

in the financial statements into percentage by
dividing each item by the base. The base shall
be equal to 100%.
2. Use the following as a base for the vertical
analyses of their respective financial statement:
a) total assets for analyzing a statement
of financial position
b) total or net sales for analyzing a
statement of comprehensive income
c) total cash available for use for
analyzing a statement of cash flows
3. Make a conclusion on the allocation and the
indications of possibilities

TREND PERCENTAGE APPROACH

- Trend percentage approach is used to analyze

the financial statements that extend beyond two
years through the use of index numbers or
percentages. It converts the absolute peso into
percentages. It makes a comparative study of
the operating performance of the business over
a number of years. Data for three years are the
minimum requirement for this type of analysis.
- In conducting trend analysis, the base year
selected must be a representative of a normal
year. A base year that is not representative of
the business's normal operation will not present
a meaningful trend, and the result of the
evaluation becomes meaningless to the users.
The base year carries an index of 100 percent.
An index that is less than 100 signifies that the
REMEMBER!!!!!
account has decreased from the base year
while an index more than 100 means that the VERTICAL
account has increased from the base year.

Guidelines that should be observed in trend

percentage analysis:

1. Present in tabular format the financial HORIZONTAL

statements covering several years. The
arrangement is usually in ascending order of
the dates.
2. Select a base year. The base year should,
however, serve as the normal operating activity
 preparation of financial statements. The
FINANCIAL STATEMENT employees and management are considered
internal users.
➢ Financial statements are considered as the final
output of the whole accounting process. They
are a structured and standardized
representation of the financial position, financial
performance, and cash flow of the business.
They also reflect the efficiency of the
management in handling the resources
entrusted to them by the owners.

A COMPLETE SET OF FINANCIAL STATEMENTS

IS COMPOSED OF THE FOLLOWING:

1. statement of financial position or condition

(more often known as balance sheet)
2. statement of comprehensive income (more
often known as income statement)
3. statement of changes in equity
4. statement of cash flow
5. notes to the financial statements

➢ While practically there is no hierarchy of

importance among the financial statements, a
good finance officer must appreciate and
understand that these are interrelated to one
another. In the Philippines, the preparation of
financial statements is based on the guidelines
and directives issued by Financial Reporting
Standard Council (FRSC). The guidelines
issued by the FRSC is called Philippine
Financial Reporting Standards (PFRSS) or
shortly referred to as Standards in accounting
and in this chapter.

USERS OF FINANCIAL STATEMENTS: GUIDELINES IN THE PREPARATION OF

FINANCIAL STATEMENTS
EXTERNAL USERS
FRAMEWORK
➢ External users are individuals or parties that are
not directly involved in the operations of the ➢ The Framework sets out the general concepts
business, but are considered as stakeholders. that underlie the preparation and presentation
They include the government agencies such as of financial statements in the absence of a
the Securities and Exchange Commission specific Standard.
(SEC), the Bangko Sentral ng Pilipinas (BSP),
the Bureau of Internal Revenue (BIR), as well as
the creditors, suppliers, customers, and STANDARDS
prospective investors.
➢ The Standards, particularly the Philippine
Financial Reporting Standards
(PFRS)/Philippine Accounting Standards (PAS),
INTERNAL USERS outlines the specific provisions and
➢ Internal users are individuals who have direct requirements in preparing and presenting
and active participation in various quantifiable financial statements.
transactions of the business and in the
BASIC REQUIREMENTS 2. Material uncertainties related to events or
conditions that may cast significant doubt upon
1. fair presentation the ability of the business to continue as a
2. going concern assumption going concern shall be disclosed.
3. accrual basis of accounting 3. When financial statements are not prepared on
4. consistency of presentation a going concern basis, the basis on which the
5. materiality and aggregation financial statements are prepared and the
6. offsetting principle reason why the business is not regarded as a
7. comparability of information going concern shall be disclosed.
8. disclosure of accounting policies 4. The management must take into account all
available information about the future in
assessing whether the going concern
FAIR PRESENTATION
assumption is appropriate.
➢ Financial statements are fairly presented when 5. When the business has a history of profitable
they include all necessary information that will operation and there is a ready access to
influence the decision of economic users. financial resources in times of need, it can be
concluded that the going concern basis of
1. Fair presentation requires the faithful accounting is appropriate without detailed
representation of the effects of analysis.
transactions as well as other events and 6. Before it can satisfy itself that the going
conditions in accordance with the concern is appropriate, in other cases, the
definition and recognition criteria for management should consider the following
assets, liabilities, income and expenses. wide range of factors relating to:
2. An application of the standards, with a. current and expected profitability
additional disclosure, when necessary, is b. debt repayment schedules
presumed to result in financial statements c. potential sources of replacement
that achieve a fair presentation. financing
3. A business whose financial statements
comply with the standards must make an
explicit and unreserved statement of such ACCRUAL BASIS OF ACCOUNTING
compliance in the notes to financial
statements. ➢ The business must prepare its financial
4. Financial statements shall not be described statements using the accrual basis of
as complying with the standards unless accounting except for cash flow information.
they comply with all the requirements of Financial statements prepared on the accrual
the said standards. basis provide the type of information about past
transactions and other events that are most
useful to users making economic decisions.
GOING CONCERN ASSUMPTION

➢ Going concern is an accounting term that CONSISTENCY OF PRESENTATION

means that a company has the resources
needed to continue operating indefinitely until it ➢ Consistency requires that the presentation and
provides evidence that it is unable to do so. classification of items in the financial
➢ Financial statements shall be prepared on a statements be retained from one period to the
going concern basis, unless management next. Thus, presentation of items in the financial
either intends to liquidate the business or to statements is consistently applied in all
cease trading, or has no realistic alternative but reporting periods.
to do so. ➢ A business, however, is not precluded from
changing the presentation and classification of
information of the financial statements subject
to the following conditions:
The following guidelines should be observed in the
a. Another presentation or classification
preparation and presentation of financial statements
of the item is more appropriate since it
relative to the going concern assumption:
will provide more relevant information
1. The management shall make an assessment of to the users.
the business ability to continue as a going b. The standards allow change in the
concern. presentation.
c. Comparability is not impaired
MATERIALITY AND AGGREGATION In applying the concept of comparability of
information, the following requirements should be
The standards have underlined the following observed:
guidelines on materiality and aggregation:
1. A comparison shall be included for narrative
1. Omission or misstatement of items is material if and descriptive information when it is relevant
it, individually or collectively, influences the to an understanding of the current period's
economic decision of users taken on the basis financial statements.
of the financial statements. 2. Comparative information shall be disclosed in
2. Materiality depends on the size and nature of relation to the previous period for all amounts
the omission or misstatement determined in the reported in the financial statements except
surrounding circumstances. when the standards permit or require
3. Each material class of similar items shall be otherwise.
presented separately in the financial 3. When the presentation or classification of items
statements. Items of a dissimilar nature of in the financial statements is amended,
function shall be presented separately unless comparative amounts shall be reclassified
they are immaterial. unless the reclassification is impracticable.
4. If a line item is not individually material, it is 4. When comparative amounts are reclassified, an
aggregated with other items either on the face entity shall disclose:
of the financial statements or in the notes. a) the nature of the reclassification
5. An item that is not sufficiently material to b) the amount of each item or class of
warrant separate presentation on the face of items that is reclassified
the financial statements may, nevertheless, be c) the reason for the reclassification
sufficient to be presented separately in the 5. When it is impracticable to reclassify
note. comparative amounts, an entity shall disclose:
6. The specific disclosure requirement in a a) the reason for not reclassifying the
Standard need not be satisfied if the amounts
information is not material. b) the nature of the adjustments that
would have been
c) made if the amounts had been
OFFSETTING PRINCIPLE reclassified

➢ Offsetting requires that assets and liabilities as

well as income and expenses are reported
DISCLOSURE OF ACCOUNTING POLICIES
separately. For example, overpayment of a
debtor should not be offset against the ➢ Accounting policies are the specific principles,
receivable. The overpayment shall be bases, conventions, rules, and practices
presented as a liability while the receivable applied by an entity in preparing and
shall be presented as asset. presenting financial statements.
➢ Offsetting in the statement of comprehensive ➢ The disclosure requirement is intended to
income and in the statement of financial enhance the relevance and reliability of the
position, except when offsetting reflects the financial statements and the comparability of
substance of the transaction or other event, those financial statements over time and with
detracts users to understand the transactions, the financial statements of other businesses.
other events, and conditions that have occurred
and to assess the entity's future cash flows.

LIQUIDITY refers to the ability of a business entity

to settle its currently maturing financial obligations.
COMPARABILITY OF INFORMATION
SOLVENCY is the ability of a business to pay its
➢ The basic objective of comparability is to assist long-term financial obligations.
users of financial statements in making
economic decisions based on the assessment
of the historical trends in the company's
financial information for predictive purposes.