High and differential inflation rates severely limit the comparability of ROCE. In Country Y, with 10% inflation, company CD's revenues reflect current prices, while depreciation is based on the lower historical cost of assets. This understates expenses and overstates the operating profit (numerator). Concurrently, the capital employed base (denominator) is significantly understated relative to its current economic value. This combination artificially inflates CD's ROCE, rendering a direct comparison with AB, from a low-inflation environment, fundamentally misleading. The ratio no longer reflects true comparative operational efficiency.

A. ROCE uses profit before tax (PBIT), so corporate tax rates do not impact the calculation, making the comparison valid.

C. ROCE uses profit before interest (PBIT), meaning different borrowing costs do not affect the ratio's components or its comparability.

D. Different currencies are not a fundamental barrier; financial statements can be translated into a common currency using standard accounting rules, enabling a valid comparison.

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1. International Accounting Standard (IAS) 29

Financial Reporting in Hyperinflationary Economies. Paragraph IN1 states

"In a hyperinflationary economy

reporting of operating results and financial position in the local currency without restatement is not useful. Money loses purchasing power at such a rate that comparison of amounts from transactions...is misleading." While the 10% inflation in the scenario is not defined as hyperinflation

the underlying principle of distortion to historical cost accounts is the same and significantly impairs comparability.

2. Atrill

P.

& McLaney

E. (2018). Accounting and Finance for Non-Specialists (11th ed.). Pearson Education. In Chapter 3

"Analysing and interpreting financial statements

" the text discusses the limitations of ratio analysis

noting: "The effects of price changes over time can distort accounting ratios. The problem is that assets acquired at different times will be expressed in the balance sheet at different prices... This can make it difficult to compare the performance of a business over time and with other businesses." (Specific discussion on inflation's impact on historical cost accounting).

3. Penman

S. H. (2013). Financial Statement Analysis and Security Valuation (5th ed.). McGraw-Hill Education. In Chapter 6

"The Analysis of the Financial Statements

" Penman discusses the problems with historical cost accounting in the presence of inflation. He explains that holding gains on assets are not recognized

and expenses like depreciation are understated

which in turn overstates income. This directly impacts both the numerator and denominator of ROCE

distorting the ratio. (See section on "Inflation and the Quality of Accounting Numbers").