Graphs reach out and seize the reader's attention. People tend to perceive and retain graphic information more quickly and easily than narrative discussion or numerical tabulation. The unique communication ability of graphics makes the well designed graph an effective communicator that can be adapted to many uses in a CPA's practice.

Graphs are effective because they are easily understood by both financial and nonfinancial people. When large amounts of data are presented in a graph, the essence can be grasped more quickly. Graphic presentation of trends, sequences and relationships takes less space than words and reduces the time needed to absorb data. Graphs allow the writer to select significant relationships for emphasis. They can expand the reader's perception by providing a formed picture. Graphs can both emphasize the significance of known relationships and illustrate relationships otherwise difficult to perceive. They enliven written and tabular material by adding spice and variety. A summary of their benefits is presented in Exhibit 1.

PROPER USE BY

ACCOUNTANTS

The graphs most widely used by accountants are bar graphs, column graphs, pie graphs and line graphs; however, other effective forms are also available.

Bar and Column Graphs

Bar (horizontal) and column (vertical) graphs are thought to be the easiest to understand, especially for readers with limited experience in interpreting numerical information. They are versatile. They can show comparisons between or among two or more items, display changes in one or more items over a period of time or make comparisons between parts and the whole.

While bar and column graphs are an effective form of communication, care must be taken to make certain that the graph communicates the intended message. Examine Graph 1 and Graph 2. Each presents a visual representation of revenue in each or several year(s). In Graph 1, the 290% increase in column height from 1985 to 1989 depicts the actual 290% increase in revenue. However, Graph 2 can easily be misinterpreted by the casual reader. The 76% increase in column height from 1987 to 1989 is not representative of the actual 39% increase in revenue. The vertical axis does not start at zero: it starts at $16,000, presumably to help the reader recognize the increase between periods. However, the visual image, by itself, is misleading. The casual reader may absorb the visual stimulus of the physical difference in height without adjusting for the perspective provided by the graph scale.

Also exercise care when choosing colors, shadings, or hatching to differentiate between different entities/units/variables represented on the same graph. For example, an unintentional bias can be introduced by color choice. Giving "Region 1" information in a cheery blue and "Region 2" information in a drab gray portrays "Region 2" in a less favorable manner.

Pie Graphs

The pie (circle) graph is a clear and interesting way to help the reader understand portions of a whole. However, the eye can better measure differences in the lengths of two or more columns than differences in the arcs or angles of the "slices" of two or more pie graphs. For example, in Graph 3, each of the three pie graphs represents one division's portions of corporate sales, operating income and assets, respectively. Comparison of the sales and operating income contributions of this division are difficult to interpret from the graphs alone. Thus, pie graphs are not the most effective way to indicate relationships between factors.

The number of segments shown in a pie graph should be held to a minimum. Graph 4 illustrates the proportion of 1989 revenues attributable to the five major special revenue funds operated by a county government. Another five medium sized and 10 small special revenue funds have been combined into a single category to avoid cluttering the graphs with small segments, which could neither be easily interpreted nor individually affect the decisions of a reader. If the relative size of the smaller segments is important, this information must be reported in a more precise (e.g., tabular) form.

Line Graphs

The line graph is used primarily to show trends or changes in trends over time. The line graph is a very efficient graph in that it can present large amounts of quantitative information in a form that allows the reader to quickly see trends and relationships. Because of the detailed nature and the significant amount of information often reported in line graphs, their use should be limited to situations where other forms of presentation are less effective. A series of complex line graphs is likely to aggravate rather than relieve information overload.

Line graphs are quite flexible and have many variations. Graph 5 contains three plotted lines. This allows the reader to see both the separate trends and the relationship between these trends. This a very efficient presentation technique, but it must be used cautiously. To avoid potential misinterpretation, the number of plotted lines on a single graph should not exceed five and normally should be limited to three.

Great care should be taken when a graph containing more than one vertical scale is prepared. Graph 6 illustrates how the selection of the vertical scale can subtly alter a graph's message. The growth rate of shareholder's equity (left vertical scale) is clearly presented. However, when introducing the right vertical scale for the equity ratio, the presenter chooses how to overlap, or not overlap, the two trend lines. If the equity ratio scale had started at either 40% or 55%, rather than 50%, there would have been no overlap. If the increments in the equity ratio scale had been 2%, rather than 5%, the 1987 peak would appear much more dramatic. On the other hand, use of 10% increments would have smoothed out this equity ratio fluctuation.

MICROCOMPUTER GRAPHICS

SOFTWARE

Microcomputer graphics software and the necessary hardware to run these packages have increased in both sophistication and ease of use. Desktop presentation soft ware packages for the personal computer can produce bar, column, line and pie graphs (and tables) from manually- entered data or from previously prepared spreadsheet data files. These packages can merge text and graphics into a single image for output as slides, overheads, or paper copy. Some have facilities that can be used to turn the financial report into a desktop screen show.

The more powerful electronic spreadsheet and database software packages often have built-in or add-on graphics capabilities that can produce reasonable quality tables and graphs. For example, Lotus 1-2-3 Release 3.0 touts over 200 variations or combinations of graphs including surface graphs and mixed bar/line graphs. It can graph input data from multiple worksheets and also print text and graphics on the same output page. Up to 14 colors or 14 hatching patterns (for black and white graphs) are available to use on a single graph.

Exhibit 2 lists some of the main features a user would desire or expect from microcomputer graphics software.

ILLUSTRATIVE USES

There are many ways to use graphs in an accounting practice. While proposals and reports to clients will be primarily textual in nature, graphs are a powerful means for presenting or supplementing the quantitative evidence supporting the CPA's analysis or position.

Proposals to Prospective Clients

Graphs can be used in proposals to prospective clients to display meaningful insights gathered in a pre-proposal survey.

For example, suppose a prospective client is having cash flow problems. A review of the financial statements indicates that most of the problem may be related to receivables and inventory. A review of receivables and inventory is proposed; how can the proposal clearly indicate the need to focus on these accounts? A graph could aid in demonstrating to the prospective client that such a review is warranted. Graph 7 illustrates how a column graph can visually depict the percentage increase in sales, receivables and inventory by year. The graph indicated in a striking way that in 1988 and 1989, receivables and inventory have increased substantially, while the percentage increase in sales has been declining. The graph would then be followed by a brief explanation of the cash flow effect of increases in receivables and inventory.

Management Letters

Opportunities to use graphs in presenting data to clients are often present in the management letter. The management letter can be used to describe conditions and observations noted while providing audit or accounting services. For example, accounting services often involve a review of operations. How could one inform the client that this review indicates that while sales and income from operations have increased substantially, cash flow from operations has decreased? A line graph could be used to emphasize these trends. Graph 8 presents a line graph with sales, cash flows from operations, and income from operations. The management letter would then identify the apparent reasons why cash flow from operations has not kept pace with sales and income.

Long Form Reports

The auditor may be requested to include a variety of materials with the basic financial statements being presented to owners/managers of privately held companies. This type of report is commonly called a "long-form" report, although that term is no longer used in authoritative literature.

Examples of supplemental data included in this report are details concerning accounts reviewed, statistical data, explanatory comments, operational data, and financial analyses. Some of this information could be effectively presented in graphic form.

Graph 9 represents an effective way to present a profitability analysis. A bar graph with selected profitability ratios and an industry comparison will give management, at a single glance, a unique perspective on the organization's current year's performance.

Analytical Procedures

SAS 56 requires the auditor to use analytical procedures in both the planning and final review stages of all audits. These procedures are an important part of the audit process. They consist of evaluations of financial information by review relationships among both financial and nonfinancial data.

The aging of accounts receivable is an analytical procedure that can be enhanced by using graphics. Visual presentation of the aging will aid in determining if the allowance for doubtful accounts is adequate. Graph 10 indicates that a significant amount of the increase in receivables in 1989 is in the older accounts. This would influence the auditor in determining the adequacy of the allowance for doubtful accounts.

Management of an Accounting

Practice

The CPA can use graphs in the management of an accounting practice. They can communicate important data to members of the firm. One example is to graph changes in the practice. See Graph 11 for a visual presentation of the percent of revenue earned from tax, compilation and review, and audit. Another example is a comparison of the percentage change in billable hours, collections, and write-offs. Graph 12 included a favorable trend in these variables over the last three years.

SUMMARY

Graphs can and should be used in an accounting practice. They effectively communicate financial information and are easily understood by both financial and nonfinancial people. CPAs using nearly any of the currently available microcomputer graphics or spreadsheet software packages can adapt graphs to fit their needs. Decide what your firm's needs and uses are for graphics. Then, do a little research into the available graphics software packages, that will satisfy your firm's needs. Once you've narrowed the field of choices, discuss and try out those packages with one or more vendors for comparison shopping for quality, service and price.

Charles H. Gibson, PhD, CPA, is Professor of Accounting at The University of Toledo, Toledo, OH.

Nicholas Schroeder, PhD, CPA, is Assistant Professor of Accounting at The University of Toledo, Toledo, OH.