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Hi John
At the end of the lecture for Accounting Conventions and Policies you ask a couple of questions regarding ‘In times of high inflation, using historical cost accounting’ would the value of a capital asset be:-
– Value in SOFP? = Under Valued
– Profit? – Over Valued
I was originally expecting the profit to actually be understated. I understand the reason you give (if the capital is higher than estimated, and so is the depreciation), however would the depreciation cost not be totally offset by the increase in the valuation of the capital which I seem to remember appears in one of accounts contributing to the profit/loss?
I am obviously wrong but could you just clear this up at all?
Thank you
The only figure that is relevant in arriving at the profit is the depreciation expense. With historic cost accounting, depreciation will be based on the original cost which will be lower than the ‘true value’. Therefore the depreciation will be lower than realistically it should be, and therefore the profit will be higher than it should be.
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