Question

If there’s an increase in fair value, how does it affect the profit in the long term? Does that mean it leads to an increase in carrying amount of an asset and depreciation will decrease in the following periods? However, why does profit decrease as a result? If there’s an increase in carrying amount of an asset, why does the profit decrease?

Answer 1

Solution :

Fair value" is defined as whatever price a buyer/ seller agree on if they know the market and both want to make the deal.

If there is an increase in the fair value of the assets, the profit recoded in the income statement is non-cash item , i.e. the cash has not been received but earned income as the value of assets is been increased. Its effect won’t be reflected in cash flow statement or neither will it be taxed as its unearned income.

The carrying amount is the recorded cost of an asset, net of any accumulated depreciation or accumulated impairment losses.

In other way we can say that, if there is increase in the fair value of the assets, then the value of carrying amount also increases and also depreciation will also get increased for the period followed by the date on which fair value of assets has been recorded.

However the profit will get decreased as a result, as depreciation get increased, which leads to increase in expenses, and results in decrease in profit. As depreciation is charged as an expense in the income statement, and deducted from the assets which decreases the value of assets in the balance sheet.

If there is increase in carrying amount of an asset , then depreciation amount will get increased, which leads to increase in expense , which results in profit decreased.