INTERNATIONAL ACCOUNTING CH 8 HW - International Accounting...

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T Anderson International Accounting Chapter 8: Additional Financial Reporting Issues 1. Why is it important that, in countries with high inflation, financial statements be adjusted for inflation? Historical cost accounting causes assets to be significantly understated in a country experiencing high inflation. Understated assets, such as inventory and fixed assets, leads to understated expenses, such as cost of goods sold and depreciation, which in turn leads to overstated income and stockholders’ equity. Understated asset values can have a negative impact on a company’s ability to borrow because the collateral is understated. Understated asset values also can be an invitation for a hostile takeover to the extent that the current market price of a company’s stock does not reflect the current value of assets. Overstated income results in more taxes being paid to the government than would otherwise be paid, and could lead to stockholders demanding a higher level of dividend than would otherwise be expected. Through the payment of taxes on inflated income and the payment of dividends out of inflated net income, both of which result in cash outflows, a company may find itself in a liquidity crisis. To the extent that companies are exposed to different rates of inflation, the understatement of assets and overstatement of income will differ across companies; this can distort comparisons across companies. For example, a company with older fixed assets will report a higher return on assets than a company with newer assets because income is more overstated and assets are more understated than for the comparison company. Because inflation rates tend to vary across countries, comparisons made by a parent company across its subsidiaries located in different countries can be distorted. 2.What are the major differences in the calculation of income between the Non-monetary assets and non-monetary liabilities are restated for changes in the general purchasing power of the monetary unit. Most non-monetary items are carried at historical cost. In these cases, the restated cost is determined by applying to the historical cost the change in general price index from the date of acquisition to the balance sheet date. Some non-monetary items are carried at revalued amounts, for example, property, plant and equipment revalued according to the allowed alternative treatment in IAS 16, “Property, Plant and Equipment.” These items are restated from the date of the revaluation. All components of owners’ equity are restated by applying the change in the general price index from the beginning of the period or the date of contribution, if later, to the balance sheet date. Monetary assets and monetary liabilities (cash, receivables, and payables) are
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This note was uploaded on 02/09/2011 for the course ACCT 547 taught by Professor Sc during the Fall '11 term at Campbell University .

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INTERNATIONAL ACCOUNTING CH 8 HW - International Accounting...

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