Definition
The Modified Historical-Cost Convention is a variation of the historical-cost accounting method where certain assets are recorded at their revalued amounts instead of their original purchase costs. This approach adapts the historical-cost convention to reflect more current asset values, as permitted by legal frameworks such as the Companies Act.
Detailed Explanation
Under traditional historical-cost accounting, assets and liabilities are recorded at their original purchase costs adjusted for any depreciation. This method is criticized for sometimes providing outdated information, especially in times of inflation. The modified historical-cost convention addresses these issues by allowing certain assets to be periodically revalued at their fair market value. This practice ensures that the financial statements more accurately reflect the current economic realities and provide better information for decision-makers.
Examples
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Real Estate Revaluation: A company owns a piece of land purchased 10 years ago for $1 million. Over the years, the real estate market value has increased significantly. Under the modified historical-cost convention, the company can revalue this land to its current market value of $1.5 million on their balance sheet.
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Equipment Upgradation: A manufacturing firm bought machinery five years ago for $500,000. Due to technological advancements, the machinery’s market value has appreciated to $700,000. Using the modified historical-cost convention, the firm can record the machinery at $700,000, rather than its depreciated original cost.
Frequently Asked Questions (FAQs)
What is the primary benefit of the modified historical-cost convention?
The primary benefit is that it provides a more accurate reflection of an asset’s current market value, leading to more relevant and timely financial information for stakeholders.
Which organizations are allowed to use the modified historical-cost convention?
Organizations covered under specific regulatory frameworks like the Companies Act are permitted to use this method, subject to compliance with prescribed rules and disclosures.
How often can assets be revalued under modified historical-cost accounting?
The frequency of revaluation depends on the regulatory guidelines and accounting standards in place. Typically, assets may be revalued annually or at intervals decided by the company’s accounting policy framework and regulatory requirements.
Does revaluation affect the income statement?
Yes, revaluation can affect the income statement. If an asset is revalued upward, the increase is typically recognized in other comprehensive income. Conversely, a revaluation downward may need to be recognized as a loss on the income statement.
Is modified historical-cost convention accepted under IFRS?
Yes, International Financial Reporting Standards (IFRS) permit the revaluation model, thus allowing organizations to revalue their assets under the modified historical-cost convention.
Related Terms
Historical-Cost Accounting
Historical-Cost Accounting involves recording assets and liabilities at their original purchase prices, adjusted for depreciation or amortization, without considering current market values.
Fair Value Accounting
Fair Value Accounting is a method where assets and liabilities are measured and reported at their estimated market value at the date of reporting.
Revaluation Reserve
Revaluation Reserve is an equity account reflecting the surplus from asset revaluation. This reserve arises from the upward revaluation of assets and is part of other comprehensive income.
Depreciation
Depreciation is the systematic allocation of the cost of a tangible asset over its useful life, reflecting its decrease in value due to wear and tear.
Online References
Suggested Books for Further Studies
- “Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield
- “Financial Accounting Theory” by William R. Scott
- “International Financial Reporting: A Practical Guide” by Alan Melville
Accounting Basics: “Modified Historical-Cost Convention” Fundamentals Quiz
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