The level of real income of a firm can be distorted by the reporting of depreciation and interest expense. During periods of high inflation, the level of reported depreciation tends to __________ income, and the level of interest expense reported tends to __________ income.
A) understate; overstate
B) understate; understate
C) overstate; understate
D) overstate; overstate
E) There is no discernible pattern.

Question

Quizplus · Accepted Answer

During high inflation, historical cost depreciation understates the replacement cost of assets, thus overstating income. Interest expense, based on historical debt, understates the real cost of borrowing, thus understating income.

The Level of Real Income of a Firm Can Be