Real value is nominal value plus inflation (or minus deflation). The real value of assets changes as the value of currency is not fixed. The inflation process leads to depreciation of money. Therefore, real value of assets presented in currency will change in time.
Inflation and Deflation
Inflation and deflation to a concept that applies to changes in the level of prices. Inflation is an economic phenomenon consisting in an increase in the general level of prices of goods and services offered in the economy and deflacja is an phenomenon consisting in an falling this prices .
Real value vs. amortization
It is important to state, that assets can be in the same time subject of amortization, which will lower their nominal value and finally impact on real value. Thus change of real value can be difficult to spot on balance sheet.
Amortization (depreciation / amortization write-off) is a monetary equivalent of consumption of fixed and intangible assets caused by its physical consumption - created as a result of exploitation and economic (moral) - resulting from technical progress related to the possibility of obtaining modern machines, devices on the market more efficient, cheaper to use, allowing you to get better quality products. This impairment is transferred to the value of products generated using the amortized fixed assets. Depreciation is a type of cost that does not constitute a monetary expense.
The depreciation starts no earlier than after being accepted for use (according to the balance sheet law), in the month following the month of entry into the register (according to tax law), and the ending when the write-offs equalize with the initial value of a specific fixed asset or put into liquidation, sales, shortage.
Basic Methods of amortization :
- Straight Line Method
- Production Method
- Uniform Rate on Diminishing Value Method
Which inflation index?
It is disputable which indicator of inflation should be taken into account. The official index of inflation is usually lower than hidden inflation that can be assessed among others by observation of M3 monetary base change
Basic Inflation index :
Real value vs. perceived value
Examples of Real value
- A real estate property is an example of a real value asset. The real value of a property is determined by its market value, which is determined by factors such as location, condition of the property, and recent sales of similar properties. As inflation increases, the real value of the property will decrease over time.
- Stocks and bonds are another example of real value assets. The real value of stocks and bonds is determined by their current market value, which is influenced by factors such as the company's performance and the overall stock market. As inflation increases, the real value of stocks and bonds will decrease.
- Gold and other precious metals are also examples of real value assets. The real value of gold and other precious metals is determined by their market value, which is influenced by factors such as the demand and supply of those metals. As inflation increases, the real value of gold and other precious metals will decrease.
- Artwork is another example of a real value asset. The real value of artwork is determined by its market value, which is influenced by factors such as the artist's reputation, the condition of the art piece, and the overall art market. As inflation increases, the real value of artwork will decrease over time.
Advantages of Real value
Real value has several advantages over nominal value:
- It gives an accurate representation of the true value of an asset, taking into account the effects of inflation and deflation. This makes it easier to compare the value of goods and services over time.
- Real value also makes it easier to measure a country's economic performance, as it eliminates the distortion caused by inflation.
- It allows investors to make better decisions, as they can compare the real value of their investments over time.
- Real value also helps in the assessment of an asset's current market value, as it takes into account the effects of inflation.
Limitations of Real value
One of the main limitations of real value is that it is subject to changes in the inflation rate. This means that the real value of an asset can decrease over time, even if its nominal value stays the same. Other limitations include:
- Difficulty in accounting for changes in the cost of living: Real value does not take into account changes in the cost of living, which can make it difficult to accurately calculate the real value of an asset.
- Lack of consistency across different countries: Real value can vary from country to country due to different inflation rates and economic policies.
- Difficulty in predicting future inflation rates: Inflation rates can be difficult to predict, making it difficult to accurately determine the real value of an asset in the future.
- Difficulty in determining the value of non-traded assets: Real value is difficult to determine for non-traded assets since their nominal value is not easily determined.
One approach related to Real value is the current-cost accounting. This method is based on the idea that assets should be reported at the cost to replace them in the current period. This approach can help to keep track of the current purchasing power of assets and provides an accurate picture of the economic value of assets. Additionally, the following approaches are also used to measure real value:
- Real Income Approach: This approach suggests that the real value of an asset should be measured by the income it can generate. This approach is usually used for investments, such as stocks and bonds.
- Purchasing Power Parity (PPP): This approach is based on the exchange rate between two currencies. It is used to compare the real value of assets in different countries.
- Cost of Living Index: This method suggests that the real value of an asset should be measured by the cost of goods in a particular period.
In conclusion, there are several approaches used to measure the real value of an asset, including current-cost accounting, real income approach, purchasing power parity, and cost of living index. Each approach can provide an accurate picture of the economic value of assets.
- Carroll College, James Schneider,(1959). Depreciation of fixed assets Business, Accounting and Economics Undergraduate Theses. 46.
- Lyle M. Bender, (May 1952). Inflation and DeflationSDSU Extension Circulars 482, pages 9.
- Michael J. Boskin, Ellen R. Dulberger, Robert J.Gordon, Zvi Griliches, and Dale W. Jorgenson (1998). Consumer Prices, the Consumer Price Index, and the Cost of Living Journal of Economic Perspective, nr 1, pages 3-26.
- O’brien, R. M. (2007). A caution regarding rules of thumb for variance inflation factors. Quality & quantity, 41(5), 673-690.
- Lyle M. Bender, Inflation and Deflation, page 9
- Depreciation of fixed assets
- The Consumer Price Index, pp 3-7.
Author: Paulina Ściera