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CMA Final · Strategic Performance Management and Business Valuation · Valuation of Assets and Liabilities

Under the replacement cost approach to valuing a machine, which adjustment is made to the current cost of acquiring an identical new machine to arrive at the value of the existing used machine?

The current cost of a new identical machine is reduced by an allowance for physical deterioration and obsolescence. This reflects the used condition of the asset. Book depreciation is merely an accounting allocation and is not the basis for the adjustment.

  1. AAdd the accumulated depreciation booked in the books
  2. BDeduct an allowance for physical deterioration and obsolescenceCorrect
  3. CAdd the expected scrap value at the end of life
  4. DDeduct only the original cost less book value

Explanation

Replacement cost new is reduced for physical deterioration and functional or economic obsolescence to reflect the used condition. Adding accumulated depreciation would raise the value above the new cost, which is illogical. Book depreciation is an accounting allocation, not a measure of market-based wear.

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