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An asset was purchased one year agao for 20$, it can now be sold for 35$ and to replace it, it will cost 25$.
Ans (as per my study text ) : Holding gain – 5$
Operating Gain – 10$.Could you please explain me how can replacement cost be considered for gains ?
Shouldn’t the Gain be just operating gain?
What is the concept behind Holding gain?
Thanks in advance
This is an attempt to recognise that, to replace assets, it will cost more than the original asset cost in the first place
When comparing $20 original cost with $35 selling value, imagine that you wanted to go through the entire process again
So you take $20 of those $35 proceeds to go and buy another asset, exactly the same as the original. But when you arrive at your supplier’s premises, you are met with the devastating news that the price is no longer $20 … it’s gone up to $25
So, of the $15 gain that you made, $5 relates to the fact that the underlying purchase price of a replacement asset has increased and only $10 relates to operating gains
(And just consider yourself lucky that your supplier didn’t say “I hear you’re selling these for $35 … so that’s the price I’m going to charge you from now on!”)
OK?
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