CFA Practice Question

There are 520 practice questions for this study session.

CFA Practice Question

Which of the following best explains why the return on assets (ROA) ratio may show distorted increases over time?
A. Net income is affected by inflation and total assets are getting older.
B. A firm acquires many new assets each period.
C. A firm may use replacement cost valuation for plant assets, and repairs and maintenance expense changes each year to correspond to asset replacement costs.
Explanation: As assets age, the net asset book value decreases and the return on assets ratio increases. This return ratio does not reflect economic substance, however, since income is measured in current period dollars while the denominator (assets) is measured using historical information rather than replacement information.

User Contributed Comments 5

User Comment
gaurav1207 why not C? if the firm is using replacement cost then the assets value will be lower!
alena1 assuming inflationary conditions, prices would have gone up therefore increasing the original purchase price.
Rvabhi Why not B? If the firm acquires new assets, the asset base would increase and depriciation expense would increase.

so, if the net income (numerator comes down) and denominator (assets increase) will lead to decrease in asset ROA?
praj24 "best explains" - Inflation and age are more guaran-damn-teed that acquiring new assets & replacement cost valuations
titi82000 Good one praj24. I was also thinking for B but A is more obvious and more obvious means the answer to pick.
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