ACCA FR Syllabus C. Analysing And Interpreting The Financial Statements - Problems Using Historic Information To Predict Future - Notes ^{1 / 4}

especially in times of rising prices

Effect on Predicting Future

1. Cost of replacing asset (in the future) MUCH higher than NBV of asset currently

2. This means higher future depreciation (and interest if a loan is needed)

3. Cost of Sales are understated (if using FIFO) - yet sales revenue keeps up to date - thus overstating profit trends

Also, the low depreciation and interest etc could have led to too many profits being distributed thus meaning more loans needed in the future potentially

So profits are overstated and assets understated - making ROCE seem higher compared to those in the future

The ‘overstated’ profit means more tax payable and maybe even employees want more wages

The understatement of assets can depress a company’s share price and may make it vulnerable to a takeover bid.

These problems can be overcome by introducing current values by following a policy of revaluations. Also IFRS's are now using Fair (current) Values more eg. Investment Properties and FVTPL items