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Q21Q

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Intermediate Accounting (Kieso)
Found in: Page 583

Short Answer

Neither depreciation on replacement cost nor depreciation adjusted for changes in the purchasing power of the dollar has been recognized as generally accepted accounting principles for inclusion in the primary financial statements. Briefly present the accounting treatment that might be used to assist in the maintenance of the ability of a company to replace its productive capacity.

Answer

Management might elect to make annual appropriations of retained earnings in contemplation of replacing certain facilities at higher price levels.

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Step by Step Solution

Step 1: Meaning of Accounting Principles 

The concepts, ideas, principles, guidelines, and rules that accountants use to compile financial statements are known as accounting principles. In addition to defining accounting standards and frameworks, they are also used by standard-setting organizations.

Step 2: Explaining the accounting treatment that might be used to assist in the maintenance of the ability of a company to replace its productive capacity. 

Instead of recording depreciation on replacement costs, management may choose to make yearly disbursements of retained earnings in the event that particular facilities need to be replaced at higher prices. Such allocations might serve to clear up any ambiguities about the amount of money available for dividends, raises in pay, bonuses, or decreased sales prices.

The necessity for these appropriations is addressed in the financial statements' supplemental financial schedules, explanations, and footnotes. (However, depreciation charges and retained profits appropriations do not result in the building of cash for asset replacement.) Profitable activities and proper money management result in the buildup of funds.)

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