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Hi Sir,
I was wondering if you could explain one of the examples that you gave in chapter 19 tutorial video.
In the video you mentioned — In times of high inflation, using historical accounting will make us over value the profit.
I do not quite get why the profit is over valued. Any chance you can explain that ?
Thanks
With our method of accounting (historic cost), non-current assets appear at original cost less depreciation, and the depreciation expense each year is based on the original cost.
When there is high inflation, the cost of replacing the assets would be a lot higher than the original cost. If depreciation were calculated on this higher value then the depreciation expense would be a lot higher and the profits would be lower.
We don’t calculate on this higher value – we calculate on the original cost. Therefore lower depreciation expense, and therefore higher profit.
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