Question

A. How does inflation distort ratio analysis comparisons for one company over time (trend analysis) and for different companies that are being compared?
b. Are only balance sheet items or both balance sheet and income statement items affected?

Answer 1

Answer (a):

The inflation distorts the ratio as their are number of things that inflate their prices differently. The prices of the rice is increasing by 1%, wheat prices are growing by 2% and salaries expenses are increasing by 5%. This means there is no consistant increase in all the commodity prices. And this issue becomes very prominent after 3 years. Trend analysis becomes meaningless when we make technological advancements which gives us edge to control the costs of the operations and inflation does the same thing but in opposite direction. It increases the cost of different operations with different percentages.

Answer (b):

Both balance sheet and income statement items would be affected because these are monetary values that would be inflated over time which will blurr the image of the entity.