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 discernable pattern.

Question

Quizplus · Accepted Answer

Depreciation is based on historic costs; thus during periods of inflation depreciation is understated, which results in the overstatement of income.In periods of inflation, interest rates are high, and thus result in the understatement of the firm's long term earning capacity.

The Level of Real Income of a Firm Can Be