The Usefulness of Accounting Information in Predicting Bankruptcy during Inflation Periods: Some Empirical Evidence

Abstract

This research examines the usefulness of the historical cost (HC) information versus current cost (CC) information and the general price level (GPL) information signals in predicting business failure. The study also examines the usefulness of CC information versus GPL when each is used as a supplement to HC information. The study focuses on predicting bankruptcy through the use of financial ratios. A comparison of these financial ratios is made to identify the type of accounting information which yields the best predictions of bankruptcy. Twenty-six firms, which failed and filed a bankruptcy petition under the Federal Bankruptcy Act of USA laws chapter VII and chapter XI between 1979 and 1987 high inflation were selected. A set of twenty-six non-bankruptcy firms was selected for matched pair sample design. A multivariate statistical technique, multiple discriminant analysis (MDA) is used to derive the prediction results. Five functions are developed based on ratios computed with HC, GPL, CC, the combined HC/CC model. Them main results of the various analyses indicate that the combined HC/Cc model has more predictive power than does the (HC, the GPL, the CC, or the Combined) models in each of the three years before bankruptcy. Hence, the usefulness of current cost information presented in annual reports can not be denied.