Question

The level of real income of a firm can be distorted by the reporting of depreciation and interest expense. During periods of low inflation, the level of reported depreciation tends to __________ income, and the level of interest expense reported tends to __________ income.a. overstate; overstateb. overstate; understatec. understate; overstated. understate; understate

Answer 1

C

Step-by-step explanation:

Depreciation Effect - During period of decelerating inflation, there is an increase in the value of assets (assets have more value). Depreciation expense increases since there is an increase in the value of assets. Therefore, income is understated .

Interest Expense Effect: During period of low inflation, cost of borrowing otherwise known as interest rate is low and interest expense is low in return. The effect of a low interest expense overstates net income.