by Current Value Accounting
In this method of price level accounting, all the liabilities and assets are represented in the balance sheet at the current values. The difference in the net assets calculated at the beginning and end of the accounting period is ascertained which is known as the profit or loss
Similar to the RCA technique, this method also includes an element of subjectivity. Moreover, it becomes difficult to determine with a relevant price index.
Replacement Cost Accounting Technique
Replacement Cost Accounting Technique is referred to as an improved version of CPP (current purchasing power technique). The major drawback of CPP is that it does not consider the price index individually related to the assets of the company.
In the RCA technique, the index used is directly related to the company’s assets and not to the general price index. However, using the RCA technique means adopting different price indices for the conversion of items in the financial statements. Therefore, it makes the calculation of the relative price index difficult in a particular case. Furthermore, this method gets criticized by thinkers due to the element of subjectivity in it.
Depreciation and Replacement of Fixed Assets:
Another problem posed by the price level changes (and more so by inflation) is that how much depreciation should be charged on fixed assets.
The purpose of charging depreciation is twofold:
(i) To show the true and fair view of the financial statements and the profitability of the concern.
(ii) To provide sufficient funds to replace the assets after the expiry of the life of the asset. Depreciation charged on historical or original cost does not serve any of the two purposes.
Suppose a machine was purchased in 2000 for Rs 1, 00,000 having a life of 10 years. In case depreciation is charged on original cost, after 10 years we shall have Rs 1, 00,000 from the total depreciation provided. But due to inflation the cost of the machine might well have gone up to Rs 2, 00,000 or even more in 2011 when the machine is to be replaced and we may find it difficult to replace the asset.
It proves that we have been charging less depreciation which resulted in overstatement of profits and higher payment of dividends and taxes in the past and insufficient funds now to enable the replacement of the asset. Hence, to rectify this, it is necessary that fixed assets are valued at replacement cost values and depreciated on such replacement cost values. But adopting replacement cost method is also not free from difficulties.
The main difficulties are as follows:
(1) It is not possible to find accurately the replacement cost till the replacement is actually made.
(2) The replaced new assets are not of the same type and quality as old assets because of new developments and improved qualities.
(3) Income Tax Act. 1961 does not provide for any other method than the actual cost method.
(4) The fixed assets should not be written-up in the balance sheet when the prices are not stable.
Hence, it may not be possible to charge depreciation on replacement cost basis. However, it is still advisable to retain profits ad restrict dividends so as to enable funds for replacement of fixed assets. For this purpose. ‘Specific Capital Reserves’ or ‘Replacement Reserves’ should be provided in addition to the normal depreciation provided on actual cost of the asset.
