Allocation: An Overview Arguments in Term Paper

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..no current market price can have a general status of fairness applicable to all firms particularly where long-term strategies for periodic assets exist" (Aiken & Aden 2005: 6). To be consistent and accurate, a current-value approach requires constant reevaluation in the context of the role of the asset, the industry, and how these impact the firm's overall financial health. Also, expected maintenance or replacement costs are not always periodic and predictable, particularly if changes in technology require an unexpected update, or there is a sudden seasonal impact upon the industry, based upon climatic conditions.

Problems/limitations associated with using replacement cost for fixed assets

The fixed asset replacement cost strategy allows an organization to define how assets are depreciated, record those assets, report the asset costs, report replacement costs, and to report other costs associated with the fixed asset. but, although the principles of "economic efficiency requires that replacing assets should be valued at opportunity cost...for specialised assets whose opportunity costs are very low, setting prices on the basis of opportunity cost" alone is not always fair ("Historic vs. replacement cost approaches," 2007, MED). Some organizations have no choice but to replace certain assets. Thus, the argument goes, some higher value has to be attributed to certain assets, as "valuing specialised assets at opportunity cost would result in the expropriation of investor funds, and undermine the continuity of supply, thereby prejudicing dynamic efficiency in the longer term" ("Historic vs. replacement cost approaches," 2007, MED). In other words, for some assets, there is not a 'choice' between two options, and replacement costs are inevitable.

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Furthermore, replacement costs may take insufficient consideration of the impact of inflation and other related costs generated by the economic environment as a whole, and other organizations that contribute to the costs the entity requires to operate. Freight costs are affected by the current price of fuel, for example.

There is also sometimes confusion as to what constitutes an improvement or a replacement of existing equipment. Sometimes, the old form of equipment is not simply available, and the organization has no choice but to use the 'improved' model, even though it otherwise might only desire to replace the existing asset. To a lesser degree, the difference between repairs and replacement can also be murky, as how much 'repair' is necessary, before it constitutes a replacement?

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