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Chapter 2: 6DQ (page 46)

Comment on why inflation may restrict the usefulness of the balance sheet as normally presented.

Short Answer

Expert verified

Inflation in an economy affects the balance sheet values of the company, as inflation results in an increase in the fair value of the fixed assets. However, the values in the balance sheet are shown on a historical basis.

Step by step solution

01

Inflation

Inflation is defined as the progressive increase in the price of the products and services in the economyand a decrease in the purchasing power of the given currency over the period.

02

Balance sheet

A balance sheet is a major component of the financial statements of the company.It is prepared to show the position of the company’s assets, liabilities and the company’s fund at the end of the reporting period.When there exists inflation, the balance may not represent the true values of its items. As a result, its usefulness gets restricted.

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Most popular questions from this chapter

Fondren Machine Tools has total assets of \(3,310,000 and current assets of \)879,000. It turns over its fixed assets 3.6 times per year. Its return on sales is 4.8 percent. It has $1,750,000 of debt. What is its return on stockholders’ equity?

Using the Du Pont method, evaluate the effects of the following relationships forthe Butters Corporation:

c. What would happen to return on equity if the debt-to-total-assets ratio

decreased to 35 percent?

Explain how the Du Pont system of analysis breaks down return on assets. Also explain how it breaks down return on stockholders’ equity

Stein Books Inc. sold 1,900 finance textbooks for \(250 each to High Tuition University in 20X1. These books cost \)210 to produce. Stein Books spent \(12,200 (selling expense) to convince the university to buy its books. Depreciation expense for the year was \)15,200. In addition, Stein Books borrowed $104,000 on January 1, 20X1, on which the company paid 12 percent interest. Both the interest and principal of the loan were paid on December 31, 20X1. The publishing firm’s tax rate is 30 percent. Did Stein Books make a profit in 20X1? Please verify with an income statement.

Arrange the following income statement items so they are in the proper order of an income statement:

Taxes

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Preferred Stcok dividends

Earning available to common stockholders

Sales

Selling and administrative expense

Gross profit
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