What is Depreciated replacement cost?

Depreciated replacement cost is an optimised form of replacement cost method to make the estimate more realistic by adding the aspect of depreciation to a simple replacement cost concept for valuation purposes.

Replacement cost is simply defined as the cost that entity has to bear in order to replace the asset with such resource that can provide the same benefits in pursuing business objectives under normal conditions. In other words replacement does not necessarily having the same asset again rather its about the future economic benefits or yield of the asset. Normally the market price is a good point to start from however, current market price is not always what entity has to bear as a consideration for benefits to be obtained.

Depreciated replacement cost normalize the replacement cost by reducing the value by taking into account the effect of accumulated depreciation. This is done to have equitable basis of valuation as if current asset for which replacement cost is determined has been in use and has depreciated over a period of time then replacement cost needs to be reduced as well to reflect the devaluation in future economic benefits on the same pattern. But as value under replacement cost may be different so its up to valuer to decide at what rate replacement cost needs to be depreciated that reflects the same level of devaluation of asset that fairly equates with devaluation in the original asset.

In short by depreciating replacement cost we are trying to achieve fair basis of valuation of the asset. As this can be fair that is the reason why IAS 16 allows depreciated replacement cost method to be used as an alternative method in case market evidence is not enough to measure the fair value of the asset to carry the item of property, plant and equipment on revaluation basis.



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