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Thank you greatly for this platform.
I just joined the FR course for June 2023.I’d like to ask, I’m a bit confused on the analogy and calculation of example 3 in chapter 1 concerning Measurement. Particularly, the part of historical costs profit. Why is it that profit is overstated (higher) in historical cost approach?
Looking at it from the example used in the lecture of asset purchased at $200,000, using historical cost, accumulated depreciation was $40k and current value in year t+2 was $160k.
On current cost, we assumed that the current cost is $250k, therefore accumulated depreciation is 50k after 2years, leaving current value at $200K.
In comparison of the 2 examples above, I think profit of $40k was made in current cost approach against historical cost, hence profit in historical cost is lower.I’m confused as to how you choose option 1 against 3, which says historical cost profit is understated and is selected as false.
Appreciate your clarification on this.Hi,
Welcome to Open Tuition! I hope yo enjoy your time with us and it helps you secure a pass in June this year.
Profit is higher under the historical cost method as the lower cost, i.e. the $40k in the example above, is not reducing the profit by as much as the profit under current cost accounting, which would be reduced by the $50k.
If we assume that profit for the year before any depreciation is $100k, then under the historic cost it would then be $60k (100 – 40) after deducting the depreciation charge, compared to $50k (100 – 50) using the current cost method. The profit under the historic cost method is therefore higher.
Hope this makes sense.
Thanks
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