Premium Essay

Advantages and Disadvantages of Historical Cost Accounting

In: Business and Management

Submitted By fen0203
Words 313
Pages 2
Advantages and disadvantages of Historical Cost accounting
Historical cost accounting has been a controversial method that experienced many criticisms over a period of time, especially since it considers the acquisition cost of an asset and does not recognize the current market value. Merits and demerits of this method are as follows.

The most obvious advantage of HC accounting is objectivity. It is a predominantly objective system, which records the original cost of an item when it was purchased. Under historical cost accounting there is no room for manipulation and “the data is supported by independent documentary evidence, such as invoice, statement, cheque counterfoil, receipt or voucher.” (Elliott and Elliott:43) Any other method for recording transactions would be less objectives since the amount being recorded would depend on individual point of view and is various from different people.

Secondly, being compared with most other methods, historical cost is an easier and cheaper way of valuation. In respect that the original cost is one that already existed and could not be amended, which is easy to determine and can be verified. Therefore, it requires less estimation for accountants to record the data and easier for auditor to inspect them subsequently.
In addition,” as a basis of fact, it is verifiable and to that extent is beyond dispute”. (Alexander and Nobes :180)

Another significant advantage of it is reliability, which is one of the key characteristics of financial reporting, as examined in the IASB’s Framework. As a past value, for most assets historical cost is more reliably determined than other current valuation such as fair value. This measurement can ensure that there are not excess benefits to users. (Alexander and Nobes:181)

Unfortunately, as every coin has two sides, HC accounting also can not avoid having drawbacks. The main...

Similar Documents

Premium Essay

Fair Value

...Discussion of the issues (2.5) * Limitation of historical cost accounting Historical cost accounting: assets are recorded at the amounts paid/ received at acquisition Problem: +) inflation, +) increase in asset values are not reflected in financial statements (wearing out of assets, increase in market value) Advantage: +) objective method: documentary evidence to prove the purchase price of an asset, or amounts paid as expense. +) costs can easily be verified. * Alternative method of accounting that have been developed to address the problem: Measurement of the elements of financial statements: measurement options rather than historical cost include: +) replacement cost/ current value: means the amount need to replace an item with an identical item. Ex: XY Co purchased a machine five years ago for $15 000. It is now worn out and needs replacing. An identical machine can be purchased for $20 000. Historical cost is $15 000 Replacement cost is $20 000 +) net realisable value: is the expected price less any costs still to be incurred in getting the item ready for sale and then selling it. Ex: XY Co's machine from the example above can be restored to working order at a cost of $5 000. It can then be sold for $10 000. What is its net realisable value? Net realisable value = $10 000 – $5 000 = $5 000 +) deprival value: is the loss which a business entity would suffer if it were deprived of the use of the asset. Value to the business, or......

Words: 2000 - Pages: 8

Premium Essay

Hca vs Fva

...Summary Accounting concepts are the rules and guidelines used in accountancy and one of these is the historical cost accounting. This concept is an accounting technique that values an asset on the balance sheet at the price paid for the asset at the time of its acquisition. Moreover, the historical cost accounting is the situation in which accountants record revenue, expenditure and asset acquisition and disposal at historical cost. This means the actual amounts of money, or money’s worth, received or paid to complete the transaction. However, there are several limitations and flaws of the traditional historical costs method. But still, historical costs are the standard form of accounting due to its unique features and convention that make it better than most bases of measurements. Table of Contents 3. ------------------------------------------------------- Introduction. 4. ------------------------------------------------------- Case 1. Relevant for decision-making. 5. ------------------------------------------------------- Case 2. Less subject to manipulation. 6. ------------------------------------------------------- Case 3. Irrelevant for decision-making. 7. ------------------------------------------------------- Case 4. Have flaws in times of......

Words: 1312 - Pages: 6

Premium Essay

Historical Cost Account

...1 historical cost accounting (hca) is the situation in which accountants record revenue, expenditure and asset acquisition and disposal at historical cost: that is, the actual amounts of money, or money's worth, received or paid to complete the transaction. 2 nature of historical cost accounting this is one of those idiosyncratic headings that teachers dream up (me too, probably!) that meant nothing to me without further explanation 3 the big advantage of hca is that it leads to absolute certainty and it fits in perfectly with the cash flow statement. Hca tells us exactly what has been paid and what has been received and therefore there is no doubt about balance sheet amounts. The alternatives, where accountants attempt to take inflation into account, can lead to many problems. There have been several forms of current cost accounting, purchasing power accounting and so on since the mid 1970s that have been proposed as alternatives to hca. The reason the alternatives have not survived, and IAS 15 on inflation accounting is about to be replaced, if it hasn't been already, is that no one can agree on the best way to represent accounting values. Hca provides definite values, other methods don't! 4 the disadvantages of hca include the fact that hca values can relate to transactions that could be a year old, 10 years old and as much as 100 years old. It's true that some businesses have old equipment and old stocks (inventories) that are still working well but that were bought......

Words: 2561 - Pages: 11

Premium Essay

Historical Cost Disavantage

...In accounting, historical cost is the original monetary value of an economic item.[1] Historical cost is based on the stable measuring unit assumption. In some circumstances, assets and liabilities may be shown at their historical cost, as if there had been no change in value since the date of acquisition. The balance sheet value of the item may therefore differ from the "true" value. While historical cost is criticised for its inaccuracy (deviation from "true" value), it remains in use in most accounting systems. Various corrections to historical cost are used, many of which require the use of management judgment and may be difficult to implement or verify. The trend in most accounting standards is a move to more accurate reflection of the fair or market value, although the historical cost principle remains in use, particularly for assets of little importance. Depreciation affects the carrying value of an asset on the balance sheet. The historical cost will equal the carrying value if there has been no change recorded in the value of the asset since acquisition. Improvements may be added to the cost basis of an asset. Historical cost does not generally reflect current market valuation. Alternative measurement bases to the historical cost measurement basis, which may be applied for some types of assets for which market values are readily available, require that the carrying value of an asset (or liability) be updated to the market price (mark-to-market valuation) or some......

Words: 1987 - Pages: 8

Premium Essay

Historical Cost

...Accounting Communication Tatiana Egipti ESSAY "What are the arguments for and against continuing the use of historical costs in accounting?" Under Historical Cost valuation method all assets are presented on the balance sheet at their nominal (original) cost at the time of their acquisition. The Historical Cost method is the method prescribed by US GAAP for use by US companies. The proponents of the Historical Cost method often point out that one of the main advantages of such method is verifiability of initial cost information. This is true because the assets’ historical costs are based on actual transaction information, not merely estimates or hypothetical transactions. Thus, the costs are measured and presented objectively and are less susceptible to manipulation by management. There is also the Cost Efficiency advantage due to the fact that most times cost information is readily available and requires very minimal effort to obtain and verify. Additionally, determination of Historical Cost does not require any estimation by accountants and can be easily substantiated for audit purposes. Because of the objectivity of Historical Costs, information produced by accounting systems based on such methodology is easily understood by the end users. On the downside, many critics of the Historical Cost Accounting argue that usefulness of such approach diminishes in the periods of inflation when the purchasing power of money changes while the book values remain unchanged. The...

Words: 404 - Pages: 2

Premium Essay

M & M Assignment

...Certified Management Accountant (CMA) is used by various professional bodies around the world to designate their different professional certifications. CMA is also called as The Institute of Management Accountants (IMA) in the United State. IMA is a collective voice of accountants and financial professionals around the world who work in business, with job responsibilities distinct from those in public accounting. The Value of CMA to the Company IMA raises awareness of management accounting, which includes jobs in decision support, plan, and control positions. Some common job titles for management accountants include: Chief Financial Officer (CFO), Treasurer, Vice President of Finance, Controller, Treasurer, Finance Manager, Internal Auditor, Corporate or Division Planner, Cost Accountant, and Staff Accountant. The four-part CMA exam covers a wider body of knowledge, including Business Analysis, Management Accounting and Reporting, Strategic Management, and Business Applications which give the accounting staff a broader background. IMA has found that more than 90 percent of all accounting and finance functions professionals work inside corporations and other business organizations, leaving about 10 percent of the work done to include auditing and testing functions. Let me know if you have any further questions about CMA. Exercise 4-1 1. The history of Elliot Industry’s marginal performance may indicate future...

Words: 2176 - Pages: 9

Premium Essay

Exploring the Pros and Cons of Fair Value Accoungting

...PROS AND CONS OF FAIR VALUE ACCOUNTING Abstract The speed of globalization in the capital markets and the increasing complexity of financial instruments have caused financial statement users to question the relevance and usefulness of historical cost accounting (HCA). The propensity to use fair value accounting (FVA) is imminent as we enter into a borderless economy and as financial markets evolve that require more current and relevant financial information. The U.S. Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) joint effort to establish a uniform accounting standard has caused alarm to U.S. companies and accounting professionals. They contend that fair value accounting has some inherent flaws that will cause adverse effects in the economy. This paper will compare fair value accounting and historical cost accounting and will discuss the advantages and disadvantages of the two valuation methods. It will also explore several issues embedded between the two valuation methods and will examine other alternatives possible to reduce the limitations inherent between the two valuations. Key words: fair value accounting, historical cost accounting, and pro-cyclicality Introduction The use of fair value accounting has gained so much attention in the past decade due to the global economy and increasing complexity of financial instruments. Many critics believe that fair value accounting offers more......

Words: 1703 - Pages: 7

Premium Essay

Land Securities

...Financial Accounting Homework Case I: Land Securities Group Should Land Securities choose the cost or fair value model for reporting its investment property in its consolidated financial statements? a) Explain the financial statement effects of the different models b) Consider the perspectives of management, (current and potential) shareholders and lenders, as well as auditors c) Take into account the different objectives of financial reporting d) Conclude with a well-reasoned decision ------------------------------------------------- Revaluation Model | | | | | | Balance Sheet | | | | Income Statement | | |   | 2002 | 2003 | |   | 2002 | 2003 | Investment Properties | | | | Revenues | 1.026 | 1.240 | Historical Cost | 4.423 | 4.785 | | Expenses | 762 | 1.010 | Revaluation Reserve | 3.377 | 3.039 | |   | | | Open Market Value | 7.800 | 7.824 | | Operating Profit | 264 | 230 | Total Assets | 8.868 | 9.008 | | | | | Liabilities | 2.831 | 3.445 | | | | | Equity | 6.037 | 5.563 | | | | | Total Equity | 8.868 | 9.008 | | | | | Revaluation Model to Cost Model transformation * Revaluation Reserve will be taken out of Balance Sheet (assets and equity) * Assets will be valued at historical costs minus accumulated depreciation (value of total assets will be much less than in the Revaluation Model) * Depreciation of historical costs will have an influence on the income statement (profit......

Words: 1438 - Pages: 6

Premium Essay


...Advantages And Disadvantages Of Current Purchasing Power (CPP) Method CPP method is useful for finding out real financial position of organization. Following are the advantages of CPP method. 1. CPP method adopts the same unit of measurement by taking into account the price changes. 2. Under CPP method, historical accounts continue to be maintained. CPP statements are prepared on supplementary basis. 3. CPP method facilitates the calculation of gain or loss in purchasing power due to the holding of monetary items. 4. CPP method uses common purchasing power as measuring unit. So, the comparative study is easy. 5. CPP method provides reliable financial information for taking management decision to formulate plans and policies. 6. CPP method ensures keeping intact the purchasing power of capital contributed by shareholders. So, this method is of great importance from the point of view of the shareholders. Disadvantages Of Current Purchasing Power (CPP) Method Following are the some major points for the critism of CPP method: 1. CPP method considers only the changes in general purchasing power. It does not consider the changes in the value of individual items. 2. CPP method is based on statistical index number which can not be used in an individual firm. 3. It is very difficult to choose a suitable price index. 4. CPP method fails to remove all the defects of historical cost accounting system. 5. The use of general price index for CPP method...

Words: 291 - Pages: 2

Premium Essay


...UNIVERSITY OF ABUJA FACULTY OF MANAGEMENT SCIENCE DEPARTMENT OF BANKING AND FINANCE COURSE: FINANCIAL ACCOUNTING (ACC312 QUESTION: THE RELEVANCE OF CORPORATE REPORTING BASED ON HISTORICAL ACCOUNTING PRACTICE HAS CONTINUED TO GENERATE INTENSIVE DEBATES OF DIFFERENT FORCES IN THE WORLD, WHICH IS ESPECIALLY TRUE IN A HIGH INFLATIONARY AND DISTORTED ECONOMY LIKE NIGERIA. DISCUSS THE STATEMENT IN RELATION TO JUSTIFICATION FOR INFLATION ACCOUNTING IN NIGERIA. NOVEMBER, 2011. INTRODUCTION Inflation account is a system of accounting which, unlike historical cost accounting takes into account changing prices. Inflation accounting is a term describing a range of accounting systems designed to correct problems arising from historical cost. Historical cost basis in financial statements Historical cost accounting became more widespread after values overstated during the 1920s were reversed during the great depression of 1930s. Most principles of historical cost accounting were developed after the Wall Street crash of 1929, including the presumption of a stable currency. Under a historical cost based system of accounting, inflation leads to two basic problems, first, many of the historical numbers appearing on financial are not economically relevant because prices have changed since they were incurred. Second, since the numbers on financial statements represent dollars expended at different points of time and, in turn, embody different amounts of purchasing......

Words: 2364 - Pages: 10

Premium Essay

Management Accounting

...Introduction According to Chand (2015), costing techniques are used by management for controlling cost and making managerial decisions. It systematically records expenses and analyses the cost of each product manufactured or service rendered by an organisation (Hariharan, n.d.). Firms choose to adapt to a specific costing theory that caters accordingly to their needs and objectives. Part 1: Evaluation of Costing Theories Costing theories are very important in business decision making. According to Hariharan (n.d.), they serve managers as a guide to make correct decisions such as what price to quote, whether to place order for inputs or whether to abandon or add a product to the production line. Costing theories also determines the price of the best alternative use of a factor of production and results in an efficient allocation of resources (Chand, 2015). The business will adopt the most profitable production inputs by identifying unprofitable activities, losses and inefficiencies (Chand, 2015) Costing theories also helps the decisions regarding the capital expenditure through the estimation of long-run function (Chand, 2015). This function will be useful to managers when deciding on the expansion or contraction of plant size in the firm and confirming that the present plant size is just nice for the output level that is being produced (Chand, 2015). It improves the overall productivity of an organisation and acts as an important guide in bringing prosperity to the firm......

Words: 1822 - Pages: 8

Premium Essay

Fair Value Accounting

...Questions for Fair value accounting case 1. What is fair value accounting, what are its advantages and disadvantages 2. How is it different from historical cost accounting 3. What are level 1, 2, 3 assets 4. Give a simple example of level 1, 2, 3 assets 5. Suggest 3 ways to improve reporting fair value assets. ------------------------------------------------- QUESTION 1: Fair value accounting is method of accounting the value of assets, liabilities and shareholders’ equity in rational and unbiased manner by taking into consideration several objective and subjective factors. The objective factors include but are not limited to acquisition/ production/ distribution costs, replacement costs, or costs of close substitutes, actual utility at a given level of development of social productive capability supply versus demand. Certain subjective factors include risk characteristics, cost of and return on capital, perceived utility, etc. Advantages of fair value accounting: 1. Timeliness: The valuation reflects the most up-to-date and market value as of reporting date. The impact of fair value measurements—whether positive or negative on a company—is the result of market forces. 2. Transparency: Investors benefit when companies disclose their views on the impact of market illiquidity in their financial reporting. Investors and other users have greater insight into management’s views as to ultimate settlement amounts. 3. Relevancy: the......

Words: 1011 - Pages: 5

Premium Essay


...Solution Manual to accompany Accounting: Business Reporting for Decision Making 4e Jacqueline Birt, Keryn Chalmers, Suzanne Byrne, Albie Brooks & Judy Oliver Prepared by Jacqueline Birt John Wiley & Sons Australia, Ltd 2012 Chapter 1: Introduction to accounting Comprehension Questions 1.1 What is a business transaction and how does it relate to the accounting process? Illustrate the concept of a business transaction with five examples relating to a mobile phone distributor. A business transaction can be defined as external exchanges of resources between the entity and another entity or individual that affects the assets, liabilities and owners’ equity items in an entity. The accounting process is the identifying, measuring and communicating of economic information about an entity to a variety of users for decision-making purposes. The first component of the process is the identification of business transactions which are then measured and communicated to the different users of financial reports. Business transactions for a mobile phone distributor include the following: 1. The contribution of capital by the owner to commence the business. This transaction would increase cash (asset) and increase capital (equity). 2. The purchase of inventory (mobile phones) on credit. This transaction would increase inventory (asset) and increase creditor (liability). 3. The payment of office rent. This transaction would decrease cash (asset) and......

Words: 6754 - Pages: 28

Premium Essay

Foreign Currency Risk

...firm XYZ faces with the expansion abroad. These are the accounting exposure, transaction exposure and the operating exposure. Accounting exposure, is defined as the exposure that a company faces due to the reduction of its value; as a result of foreign exchange differences between the currency used in the main branch and the currency used in the other country (Gertler, Kiyotaki and Queralto, 2012). Accounting exposure is also referenced as translation exposure. The item most affected by this risk is the balance sheet. This is because the balance sheet is the statement which shows the net worth of a company. Transaction exposure is the risk that a company involved in international trade might incur. Upon entering into an agreement, a company may have to pay higher costs to meet those financial obligations as a result of changes in the foreign exchange. Unlike economic exposure, transaction exposure is well-defined and short-term. Transaction exposure is simply the amount of foreign currency that is receivable or payable. Operating exposure is the risk that a firm with a foreign subsidiary faces when meeting expenses in the foreign country as a result of unexpected changes in the foreign exchange rate. Mitigation of Exposure To mitigate the risk associated with each type of exposure, several options are available to the CEO. One of the strategies is the balance sheet hedge. This is usually applied with accounting exposure. Hull (2012) defines the balance...

Words: 998 - Pages: 4

Premium Essay

Afa1 Aqua

...AFRB 343 Advanced Financial Accounting 1 Semester 11 2011 / 2012 TUTORIAL: AQUACULTURE QUESTION 1 The data below is related to Aqua Tiger Bhd that cultures and sells tiger prawns as at 1 January 2006: Batch 1 Batch 2 (RM) (RM) Direct labour costs 40,000 10,000 Production overhead 20,000 30,000 Seed stock, fertilizer and chemical 15,000 25,000 Costs to complete the cycle 90,000 100,000 Estimated harvest 10,000 kg 15,000 kg Required: a) Determine the estimated total costs upon completion and estimated profit for each batch if the selling price for the tiger prawns is RM12/kg. b) If provision for batch 1 and batch 2 is RM16,000 and RM8,000 respectively, calculate the value of the closing stock at NRV and at cost 1 QUESTION 2 Marakisa Bhd involves in the aquaculture activities. The company has built 10 ponds and each pond takes 3 months to generate revenues. Therefore allowing Marakisa to operate 4 phases annually. Detail information on the costs and revenues for the year 2006 is as follows: Types of cost Land acquisition Facilities (road and sewage) Ponds, equipment, water pump and generator Direct labour wages Supervisor’s salary Material costs Transportation costs Revenue: Phase 1 Phase 2 Phase 3 Phase 4 Amount (RM) 520,000 15,000 2,540,100 600/month 1,200/month 5,000/month 5% from revenue 575,800 620,300 490,000 680,400 sales i. ii. Additional information: Ponds and other equipment is depreciated at 10% per annum on a straight line basis. A worker is assigned......

Words: 535 - Pages: 3