There are a couple of problems using historical cost-based financial statements in an inflationary environment. First, the numbers that appear on the financial statements no longer reflect economic reality; that is, they are based on a unit of currency whose value is no longer the same. For example, if a loan was taken out to purchase a factory last year for $10,000 dollars, but the same factory now costs $20,000 this year due to hyperinflation, both the factory and loan payable of $10,000 do not accurately reflect the value of the factory or the true liability of the payable. Second, dollar amounts financial statements are no longer additive in an inflationary environment. For example, one cannot add the cost of inventory from last year with the amount of cash on hand today to determine the value of current assets, the value of the inventory purchased last year has declined and in a sense is valued on a different unit of account (a deflated dollar) than today's cash. Also, horizontal analysis of financial statements will not be accurate. Comparing the level of sales or expenses from this year to last year will not give an accurate measure of the actual change in economic performance of the business. The sales or expenses from last year would have to be remeasured to today's value of the dollar for the comparison between periods to be apples to apples.
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