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Identify any favorable and unfavorable trends in the following income statements by preparing a vertical analysis. (Round percentages to two decimal places.)

Red Corporation
Income Statements
For the Years Ended December 31
Year 2 Year 1
Revenues 530,000525,000
Operating expenses:
Wages expense 90,500 88,000
Rent expense 35,500 35,000
Utilities expense 7,750 7,750
Insurance expense 15,000 12,000
Total operating expenses 148,750142,750
Net income 381,250382,250

User Zdebra
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1 Answer

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Final answer:

A vertical analysis of the income statements for Red Corporation shows increased expenses in relation to revenue, indicating an unfavorable trend in cost control and a slight decline in profitability, though the company's revenue did grow.

Step-by-step explanation:

To identify any favorable and unfavorable trends in Red Corporation's income statements, a vertical analysis needs to be performed. This analysis expresses each item within the statement as a percentage of a base figure, which is the total revenue for the period.



Vertical Analysis

Revenues - Year 2: 100% (baseline), Year 1: 100% (baseline)

Wages expense - Year 2: 90,500 / 530,000 = 17.08%, Year 1: 88,000 / 525,000 = 16.76%

Rent expense - Year 2: 35,500 / 530,000 = 6.70%, Year 1: 35,000 / 525,000 = 6.67%

Utilities expense - Year 2 and Year 1 both remain at 1.47% as there is no change in expense or revenue

Insurance expense - Year 2: 15,000 / 530,000 = 2.83%, Year 1: 12,000 / 525,000 = 2.29%

Total operating expenses - Year 2: 148,750 / 530,000 = 28.06%, Year 1: 142,750 / 525,000 = 27.19%

Net income - Year 2: 381,250 / 530,000 = 71.94%, Year 1: 382,250 / 525,000 = 72.81%



The analysis shows that the percentage of wages, rent, and insurance expenses to total revenue increased from Year 1 to Year 2. This indicates an unfavorable trend in control over those costs, as they take up more of the revenue pie. However, the net income percentage decreased from Year 1 to Year 2 which suggests a slight decline in profitability. Note: Despite the net income dollar amount being lower in Year 2, the overall revenue growth from Year 1 to Year 2 means the business is still growing in size.

User Zygro
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