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Hello there again
There was a question that was in regard to find whether the following statement was true or false
In times of rising prices, the use of historial cost accounting tends to understate assets and overstate profits.
This question is apparently true and I don’t really understand why
I understood the first part where it says that it understates assets because there was not much inflation back then compared to present value (eg- $10 back in 1940’s would have had a great value compared to the present 2021..)However I’m not sure about what it refers as overstating profits on the other hand
Is it saying overstating profit because the opening inventory is understated since it was recorded to the inflation of the previous year..thus opening inventory could be less than closing inventory making cost of sales lower..overstating profitsIs this logic correct for this question..i’m not sure whether my idea is even correct at all so i just asked you to see whether it is correct or nor
It seems that you are not watching my free lectures, because I specifically discuss this very thing in my lectures on accounting policies and conventions.
Because the historic cost convention uses the book value of assets which is going to be lower than the current value, the depreciation charge will be lower than it would be were it charged on the current value. By charging lower depreciation the resulting profit will be higher than it would be if depreciation was charged on the current value.
Inventories are not relevant to this because inventories are rarely held for very long and therefore the impact of inflation will be minor if at all.
Please do watch the lectures. You cannot expect me to retype out my lectures here 🙂
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