What Is Current Cost?
Current cost is the amount a company pays for replacing an equivalent asset in the current market. The purpose of this concept is to accurately represent the value of an organization’s assets and inventory by reflecting the current market prices.
This concept is useful when a company has to make pricing decisions. Companies use this concept to determine the value of their assets and depreciate them based on the cost of replacing them in the current period. As a result, this approach is applied in various accounting contexts, such as inventory valuation and fixed asset accounting.
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- The current cost definition refers to an asset’s inflation-adjusted value or the expense of replacing an asset or stock with the new one.
- It doesn’t impact the operation or financial capital of the company. Furthermore, Investors, creditors, and shareholders also use this concept to assess the real-time value of replacing a company’s assets
- Current Cost Accounting (CCA) is an accounting method that records the business items in the financial statement at their net current replacement cost.
- It is opposite to the historical cost that emphasizes recording the items at their actual or nominal value.
Current Cost Explained
The current cost means that the cost of an asset is not necessarily the same as its original purchase price or book value. It is the real-time valuation of an asset’s replacement. However, it doesn’t affect the company’s operating cost or capital. Therefore, inflation is affecting businesses and asset prices to a great extent. This concept serves as a crucial parameter to determine their fair economic value or current value.
Investors, shareholders, creditors, and financiers are more interested in tracking the cost of the company’s assets instead of their historical prices. It even helps to compare the financial statements to gauge the change in the value of assets across various accounting periods. Moreover, it is a wise idea to determine the replacement cost of the assets. When the business runs majorly on fixed assets like machinery that require replacement after a certain period.
Furthermore, by knowing the current cost basis of inventory items, an organization can determine the cost of goods sold and the gross profit margin. Hence, this can help in making accurate pricing and inventory management decisions. Furthermore, the current cost index is typically employed to monitor variations in the prices of goods and services over time. It is used to adjust historical cost data, allowing for a more precise assessment of the actual cost of an asset or liability in dollars.
Therefore, using this index is particularly relevant in industries where the prices of products and services change rapidly. Besides, the current cost index may be based on various data sources, including market prices, inflation rates, and other economic indicators. Overall, this method provides a more accurate estimate value of an asset and can aid firms to make better-informed financial decisions.
Current Cost Accounting (CCA) Method
The current cost accounting (CCA) is an inflation accounting method first framed by the Inflation Accounting Committee (IAC) of the United Kingdom in 1975. It later got recognition as an accounting method under the Statement of Standard Accounting Practice (SSAP 16). Therefore, current cost accounting is an accounting method that values assets and liabilities at their current market prices. Thus, it emphasizes recording the items’ current costs in the profit and loss account and balance sheet.
It functions on the principle that the business often requires the replacement of the existing assets to ensure efficiency. It helps the company to achieve a profitable value to distribute dividends to the shareholders. The following are the primary treatments under the CCA method:
- Fixed assets and stocks are recorded in the books of accounts at their net replacement value,
- A separate profit and loss statement is prepared to depict the profit or loss arising when the items are valued at their current cost.
- The fixed assets are depreciated at their current values.
- The current value as of the consumption date is considered for recording the inventory consumed.
However, the current cost method still needs to be recognized as the GAAP for preparing the company’s financial statements. Moreover, it is accepted by the Financial Accounting Standards Board (FASB). The FASB mandates companies with plant, property, equipment, and inventory worth over $125 million or total assets valued over $1 billion to record the items at their current costs in the income statement.
Let us understand the concept better with the help of an example.
Suppose Turner Construction Company owns a building that it purchased for $1 million five years ago. Furthermore, the company estimates that the useful life of the building is 20 years, meaning that it depreciates the facility by $50,000 per year ($ 1 million / 20 years).
However, due to significant changes in the real estate market, the current market value of the building has increased to $1.5 million. Therefore, using the current cost method, the company would revalue the building to reflect its current market value of $1.5 million.
Hence, assuming five years have passed since the company purchased the building, the total depreciation would be $250,000 (5 years x $50,000 per year). Therefore, after revaluing the building, the company would adjust the book value of the building by subtracting the accumulated depreciation from the current market value. As a result, the adjusted book value of the building would be $1.25 million ($1.5 million – $250,000).
So, by using this concept, the company can provide an accurate picture of the value of its assets and better reflect the current market conditions.
Let’s say Patrick Industries produces a product that requires a specific raw material. The company purchases 1,000 units of raw material for $10 per unit, meaning the historical cost of the raw material inventory is $10,000. However, due to the changes in the supply and demand of raw materials, the current market price has increased to $12 per unit.
The company would revalue its raw material using the current cost concept to reflect the current market price. As a result, the new value of the inventory would be $12,000 ($1,000 units x 12 per unit). Since the company uses raw materials to produce its product, it would also need to adjust the cost of goods sold and the value of the finished goods inventory to reflect the new price of the raw material.
Therefore, using this method, the company can make more informed financial decisions and better manage its resources.
Current Cost vs Historical Cost
The current cost of an asset is way different from its historical cost. Moreover, both have different uses in accounting. Given below is a comparative study between the two:
|It is the expense incurred on replacing an existing asset with another one.
|Historical cost refers to valuing assets at their original asset price.
|Its calculations are quite complex.
|It is simply the book value of an asset after charging the depreciation.
|Depreciation is charged on the asset’s current value.
|Depreciation is computed on the asset’s book value.
|Adjusted for Inflation
|It helps in comparing the value of assets in different accounting periods
|No scope for comparison
|Useful in periods of inflation or volatile market conditions
|Helpful in stable market conditions
Frequently Asked Questions (FAQs)
Yes, the current cost is a type of current value. It reflects the current market value of an asset, as opposed to the historical cost which reflects the original purchase price. However, the current value is the amount the business would realize from selling a particular asset today. Thus, the former is a broader concept in comparison to the latter.
CCA is an inflation accounting method that records the business assets at their real-time, current, or fair market value. It is a more relevant approach for organizations that operate in countries with high inflation or deflation rate.
It even facilitates the company to compare the economic value of assets in the different accounting periods.
The alternative is the historical cost, which is the purchase price of an asset adjusted for depreciation.
This has been a guide to what is Current Cost. Here, we explain it with its examples, comparison with historical cost, and accounting method. You can learn more about it from the following articles –