Question

Keeping an asset implies reinvestment in the asset. Finance theory is consistent with the notion that reinvestment is at current value, or replacement cost. Such a decision is presumably based on comparing expected future cash flows that will be generated by the asset and the cost of replacing it with a new one that could generate the same or different cash flows. According to the conceptual framework, the purpose of financial statements is to provide information regarding performance. Investment or reinvestment decisions are a part of that performance. Yet, the historical cost of fixed assets is retained and allocated over subsequent accounting periods. Required: a. Present arguments in favor of cost allocation.

Answer 1

Assets are purchased by commiting substantial corporate resources to acquire them.The initial investment cost incurred to acquire those assets represent the cost incurred in them AND it satisfies the objective of principle evidence because it can determine initial valuation of long term assets. Moreover, historical cost or the actual cost incurred is varifiable and and reilable than other valuation methods like replacement cost. Methods like replacement cost and NRV are quite subjective and can be manipulative to improve the performance wrongly thus defeating the purpsoe of conceptual framework. Thus, it is better to allocate the cost on historical basis because of its verifiability, reliability and satisfaction of conceptual framwok.