What indicates that common-size financial statements are created incorrectly?

Common-size financial statements are created to facilitate comparison across different companies or time periods by standardizing financial metrics, typically by expressing each line item as a percentage of a relevant total, such as total revenue for the income statement or total assets for the balance sheet. Dividing by irrelevant figures undermines the purpose of these statements, as it leads to misrepresentations of financial performance and alters the context in which the data is interpreted.

Using irrelevant figures would cause the computed percentages to be skewed or meaningless, thus preventing stakeholders from making informed comparisons or analyses. For example, if total liabilities were used incorrectly as a denominator when evaluating income statement items, the resulting figures would not reflect an accurate picture of revenue, expense, or profitability ratios that are normally presented in a common-size format.

The incorrect use of bases or figures in the construction of common-size statements renders them less useful for decision-making or analysis, emphasizing the significance of selecting relevant denominators to maintain clarity and accuracy.