Express the items in common-size percents.
Current YearPrior Year
Accounts receivable
$8,190
$8,750
Equipment, net
Land
55,500 18,900
45,500 42,400
Total assets
96,240 69,000
$205,430 $139,050
Cash
Current YearPrior Year
%
%
%
%
%
%
Cash
Accounts receivable %
Equipment, net
Land
Total assets
%
%
%
The Correct Answer and Explanation is :
To express the items as common-size percentages, you need to calculate each account as a percentage of total assets for both the current and prior years.
The formula for calculating the common-size percentage is:
[
\text{Common-Size Percentage} = \frac{\text{Account Balance}}{\text{Total Assets}} \times 100
]
Current Year Calculation
- Cash:
[
\frac{\$8,190}{\$205,430} \times 100 = 3.99\%
] - Accounts Receivable:
[
\frac{\$8,750}{\$205,430} \times 100 = 4.26\%
] - Equipment, Net:
[
\frac{\$55,500}{\$205,430} \times 100 = 27.03\%
] - Land:
[
\frac{\$18,900}{\$205,430} \times 100 = 9.20\%
] - Total Assets:
[
\frac{\$205,430}{\$205,430} \times 100 = 100\%
]
Prior Year Calculation
- Cash:
[
\frac{\$8,750}{\$139,050} \times 100 = 6.29\%
] - Accounts Receivable:
[
\frac{\$8,190}{\$139,050} \times 100 = 5.90\%
] - Equipment, Net:
[
\frac{\$45,500}{\$139,050} \times 100 = 32.74\%
] - Land:
[
\frac{\$42,400}{\$139,050} \times 100 = 30.53\%
] - Total Assets:
[
\frac{\$139,050}{\$139,050} \times 100 = 100\%
]
Summary of Common-Size Percentages
Current Year
- Cash: 3.99%
- Accounts Receivable: 4.26%
- Equipment, Net: 27.03%
- Land: 9.20%
- Total Assets: 100%
Prior Year
- Cash: 6.29%
- Accounts Receivable: 5.90%
- Equipment, Net: 32.74%
- Land: 30.53%
- Total Assets: 100%
Explanation:
Common-size analysis helps in comparing financial statements over different periods or across companies, as it normalizes financial data by expressing each item as a percentage of total assets. This makes it easier to identify trends, such as the increase or decrease in specific assets over time, regardless of the size of the company.
For instance, you can see that in the current year, cash has decreased significantly as a percentage of total assets (from 6.29% in the prior year to 3.99%). Equipment, net has increased as a percentage of total assets (from 32.74% to 27.03%), while land has decreased sharply in percentage terms, from 30.53% to 9.20%. This indicates a significant shift in asset composition, where the company might have invested less in land or divested part of it, while investing more in equipment.
The common-size approach provides a clear view of how each category of assets relates to the company’s overall asset base, helping investors, analysts, and management to evaluate performance and make informed decisions.