Replacement cost accounting (current cost method) during a period of inflation will usually
A) increase assets, decrease net income before taxes, and lower the return on equity.
B) increase assets, increase net income before taxes, and increase the return on equity.
C) decrease assets, increase net income before taxes, and increase the return on equity.
D) None of the options apply.

Question

Quizplus · Accepted Answer

Replacement cost accounting (current cost method) involves valuing assets and liabilities at their current market values. During a period of inflation, the current market values of assets are likely to be higher than their historical cost. Therefore, using replacement cost accounting will result in an increase in the value of assets on the balance sheet. However, since the cost of goods sold will also be higher due to inflation, net income before taxes will decrease. This is because the increase in revenue will not offset the increase in the cost of goods sold. As a result, the return on equity will also decrease, as net income will be lower than it would have been without using replacement cost accounting.

Replacement Cost Accounting (Current Cost Method) During a Period of Inflation