When a horizontal analysis is performed and a zero or negative amount is reported in the base year, then
a. no percentage change can be computed.
b. the percent change will be negative.
c. the accountant has made a mistake.
d. the percentage change will be 100% or greater.
The correct answer and explanation is :
Correct Answer:
a. no percentage change can be computed.
Explanation:
Horizontal analysis, also known as trend analysis, is a financial analysis technique that compares financial statement data across multiple periods to identify trends and changes over time. The process typically involves calculating the percentage change from a base year to a comparison year using the following formula:
[
\text{Percentage Change} = \left( \frac{\text{Current Year Value} – \text{Base Year Value}}{\text{Base Year Value}} \right) \times 100
]
However, when the base year value is zero or negative, this formula becomes problematic for the following reasons:
- Division by Zero Issue
- If the base year value is zero, the denominator in the percentage change formula becomes zero. In mathematics, division by zero is undefined, meaning no valid percentage change can be computed.
- Negative Base Year Values
- If the base year value is negative, the percentage change formula results in misleading or non-meaningful results. For example, if the base year shows a loss (negative value) and the current year reports a positive amount, the percentage change calculation may suggest an unrealistic or infinite increase, making the analysis unreliable.
- Accounting Principles and Interpretation
- When a company reports a zero or negative value in a base year, analysts typically look at absolute changes rather than percentage changes. They may analyze trends qualitatively instead of mathematically computing percentages.
Thus, the correct answer is option (a): no percentage change can be computed, because attempting to calculate a percentage change with a zero or negative base year value leads to undefined or misleading results.