Fixed Asset Lives and Replacement Cost Accounting

Abstract

In depreciating and valuing fixed assets, companies in Britain, on the whole, have traditionally ignored inflation. At the same time, however, they have also seriously underestimated the economic lives of their fixed assets. These errors appear to have offset each other fairly completely so far as reported annual depreciation charges are concerned. That is, the annual depreciation charges reported by industrial and commercial companies appear to have been roughly the same as they would have been if the companies had used replacement cost accounting together with realistic estimates of asset lives. But in the process, the two errors have combined to produce a serious understatement of fixed asset values, compared with a valuation at current replacement cost. The implication of this result is that the adoption of replacement cost accounting (otherwise known as current cost, or current value, accounting) is unlikely to result in a complete improvement in financial reporting unless companies also adopt more realistic estimates of fixed asset lives. While British companies, by and large, have not made explicit allowances for inflation in their external financial reports in the past, this situation, clearly, will change as a result of the British standard on inflation accounting (Statement of Standard Accounting Practice No. 16 [1980]; henceforth SSAP 16), which applies to accounting periods beginning in 1980. However, if the arguments presented here are correct, the new situation could be even worse than the old. In this paper, accounting data for seven years are examined, and a comparison is made between the reported depreciation charges of British industrial and commercial