# Replacement Cost Accounting Technique (RCA)

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.

## Example

 Year of purchase Cost of Assets Life in years % of Dep. 2017 50,000 20 5% 2018 80,000 10 10% 2019 1,40,000 7 15%

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.

### Solution

 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 2,70,000 4,10,000

### Journal Entries

1. Using Index No.

 Dr. Cr. Fixed Asset Account 1,40,000 To Cap. Res. A/c 1,40,000

2. Profit and Loss Account

 Dr. Cr. Fixed Asset Account 93,000 To Cap. Res. A/c 93,000

(Being excess Dep. required on CPP basis)

3. Fixed Assets

 Dr. Cr. Fixed Assets 60,000 To Cap. Res. A/c 60,000

(Being increased value of fixed assets on RCA basis)