Question

Explain the following terms:

1. historical cost

2. mark-to-market

3. net realizable value

4. replacement cost

5. future profits

6 price-level adjusted historical cost

Answer 1

1. Historical cost -

Historical cost is the original cost of an asset at which asset has been acquired by the entity. It is the purchase cost of an asset.
This concept is clarified by cost principle, which states that you should only record an asset, liability, or equity should be recorded at its original acquisition cost. Traditionally most of the transactions are stated at their historical cost.

A historical cost can be easily proven by accessing the source purchase or trade documents. However, historical cost has the disadvantage that it does not necessarily represents the actual fair value of an asset, which is likely to diverge from its purchase cost over time. For example, the historical cost of a building purchased 10 y ears ago was $1million, but its current market value is five times i.e. $5 Million.

2. Mark to market -
Mark to market is a practice that involves adjusting the value of an asset to reflect its current market value or fair value.

It provides more accurate measurement or valuation of assets or investments of a company

3. Net realizable value -

Net realizable value is estimated sale price of goods, minus cost associated with sale or disposal.
Net realizable value = Sale Price - Cost of Sale
It is a valuation method. It is commonly used in valuing inventory.
Net realizable value (NRV) is a conservative method for valuing the assets as it estimates the net amount that the seller would get net of costs if the asset is sold.

4. Replacement Cost -

Replacement cost is a cost that is required to replace any existing asset with any other asset having a similar characterstics

It refers to an amount that an entity has to pay to replace an asset at a current time , according to its current worth.

Example - . If a company bought a machine for $ 500 two years ago, and machine value today, less depreciation, is $100 dollars, then the book value of the asset is $100. However, the cost for replacing that machine at current market prices may be $1,500.

5. Future Profit -

Future Profit is profit that an entity expects to earn in coming periods.

If any entity is establishing a New business and to  measure its  profitability in future they use the method by discounting present value of future profits expected by the business in a given period of time.

6. Price-level adjusted historical cost

Price - level adjusted historical cost adjusts value of assets and liabilities with respect to the changes in purchasing power of the currency rather than changes in value of the asset. This method is mostly used in the countries in which there is a high rate of inflation and it is difficult to value the asset as they does not use historical cost method for valuation of asset.