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ACCA Applied Knowledge · Financial Accounting · Importance and purpose of analysis of financial statements

Which of the following is a limitation of financial statement analysis caused by inflation?

With inflation, assets held at historical cost are carried at outdated lower values while revenue reflects current prices. Ratios such as ROCE and asset turnover may therefore look better than the underlying reality, and comparisons over time become misleading. This is an inflation-related limitation of financial statement analysis.

  1. ARatios can no longer be calculated
  2. BNon-current assets carried at historical cost may be understated, so trend comparisons over time can be misleadingCorrect
  3. CRevenue is always recognised earlier
  4. DLiabilities are automatically revalued upward

Explanation

Under historical cost, assets bought years ago are carried at old prices while current revenues are in current prices. This can overstate ROCE and asset turnover and distort trend comparisons across years. Ratios can still be calculated, and inflation does not change revenue recognition or revalue liabilities.

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