Replacement Cost Accounting Technique (RCA) is an improvement over current purchase power (CPP) as it suffers from the that it does not take into the individual price index related to the particular assets of a company. The RCA technique uses the index directly relevant to the companies individual assets and not the general price index. Therefore RCA technique is considered to be improved over the current purchasing power technique. While using the Replacement Cost Accounting Technique will mean using a number of price indexes for conversion of financial statement and may not be difficult to find out the relevant price index to be used in a particular case.
Depreciation and Replacement of Fixed Assets
The price level change poses a problem about charging Depreciation on Fixed Assets. The main object of Depreciation to show correct profit and loss account and to make a provision for its replacement after its long use. When Depreciation is charged on historical cost does not match the above two objects.
Let us take an example to make it clear. A machine costs $1,00,000 its life is 10 years, Depreciation is on original cost, thus after 10 years we have 1,00,000 but the cost of the same machine due to inflation has gone to $2,00,000, now a problem how to replace it. Thus, it is recommended that fixed Assets be valued at replacement cost values.
|Year of purchase||Cost of Assets||Life in years||% of Dep.|
The general price index number in 2017 (base year) was 100, 2018 (200) and 2019 it was 300. The replacement cost of the Assets was %80,000, $1,00,000 and $1,50,000 respectively.
Calculate the amount of depreciation upto 2019 on historical cost and current purchasing power basis and make necessary adjustment in the ledger using the index number and replacement cost.
|Year||Historical Cost||Index||Current Valuation||$|
|2017||50,000||100||(50,000 x 300) / 100||1,50,000|
|2018||1,00,000||200||80,000 x 300 / 200||1,20,000|
|2019||1,40,000||300||1,40,000 x 300 / 300||1,40,000|
1. Using Index No.
|Fixed Asset Account||1,40,000|
|To Cap. Res. A/c||1,40,000|
2. Profit and Loss Account
|Fixed Asset Account||93,000|
|To Cap. Res. A/c||93,000|
(Being excess Dep. required on CPP basis)
3. Fixed Assets
|To Cap. Res. A/c||60,000|
(Being increased value of fixed assets on RCA basis)