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

Limitations of Historical Cost Accounting

...Limitations of historical cost accounting Financial statements prepared on the historical cost basis do not necessarily lead to a true and fair presentation of an entity’s performance or future potential if capital is not being maintained. Furthermore, actual assessment of performance through ratios such as return on capital are meaningless if profit are overstated, capital undervalued, and assets are valued under a mixture of conventions. Limitations of historical cost accounting include : • Depreciation charged on historically costed assets is only an arbitrary amount based on out-of-date values and estimated useful economic lives. • Depreciation charges do not take into account actual replacement cost of assets at current prices. • Profit will not reflect the actual ‘costs’ of trading, which include the replacement of assets at some point in time. • By not accounting for inflation, there is no assurance that the entity is maintaining its capital base. • Overstating profits by undercharging depreciation based on historical cost, and charging cost of sales at historical cost of inventories (and not current cost) can lead to the depletion of an entity’s capital through high tas charges and distributions. • While historical cost accounting provides a consistent basis for entities to prepare accounts, inflation affects different products and markets, and hence entities, to different degree. • Historical cost accounting makes it difficult for shareholders and......

Words: 323 - Pages: 2

Premium Essay

Trade Off Between Fair Value Accounting and Historical Cost Accounting

...3. Trade off between fair value accounting and historical cost accounting a) Relevance: Financial information is relevant when it influences the economic decisions of users, Fair value reporting is more relevant as it will allow users of financial statements to obtain a truer and fairer view of the company's real financial situation since it reflects the prevailing economic conditions and the changes in them. In contrast, historical cost accounting shows the conditions that existed when the transaction took place and any possible changes in the price do not appear until the asset is realized. b) Reliability: This relates to the degree of assurance capable of being obtained through verification that information faithfully represents what it purports to represent. Historical cost is considered more reliable as fair value requires estimations. FASB has expand the disclosures and framework for all companies to enhance the reliability of fair value accounting. However the drawbacks of the FV accounting is still holds as many of the valuations incorporates many subjective input data and assumptions. c) Decision usefulness: In general, financial information is considered to be useful if it enhances one's ability to make investment and credit decisions. (i) For investors: Investors will need to broaden their knowledge of fair value measurement methodologies to effectively analyze a company's financial statements and make a sound comparison. Given that institutions may use......

Words: 449 - Pages: 2

Premium Essay

Advantages and Disadvantages of Convention and Concept

...Advantages of accounting concepts, conventions and regulations. There are many advantages that accounting concepts have on financial statements. Four important accounting concepts that underpin the preparation of any sets of accounts one of which is going concern that helps an account to assume for any future problems that occur in a business. This helps companies to make future plans and gives them time to gather money to sort out any financial problems. Consistency also has an advantage in helping in accounting by users of accounts can make more meaningful comparisons of financial performance. Prudence helps investors sort out financial performance such as future problems and cost of the business before recognising any signs of profits. Accruals also help financial data to be useful for users by all business revenues and cost are recorded in the appropriate statements and at the appropriate time. Conventions also have many advantages in influences financial statements to be useful for investors. Separate entity is one example this convention seeks to ensure that all private transactions and matters relating to the owners are segregated from transactions that relate to the business. This is an advantage because owner’s transactions are kept private. Also they are not mixed with the business finance so that users can clearly see the business financial state. Also materiality is also an important convention in a business financial statement use for users. The preparation...

Words: 1407 - 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

Free Essay

Historical Cost

...Question 6 Evaluate, using appropriate examples, the relative advantages and disadvantages of ratio analysis as an aid to decision-making by investors. Advantages and Uses of Ratio Analysis There are various groups of people who are interested in analysis of financial position of a company. They use the ratio analysis to workout a particular financial characteristic of the company in which they are interested. Ratio analysis helps the various groups in the following manner: - 1. To workout the profitability: Accounting ratio help to measure the profitability of the business by calculating the various profitability ratios. It helps the management to know about the earning capacity of the business concern. In this way profitability ratios show the actual performance of the business. 2. To workout the solvency: With the help of solvency ratios, solvency of the company can be measured. These ratios show the relationship between the liabilities and assets. In case external liabilities are more than that of the assets of the company, it shows the unsound position of the business. In this case the business has to make it possible to repay its loans. 3. Helpful in analysis of financial statement: Ratio analysis help the outsiders just like creditors, shareholders, debenture-holders, bankers to know about the profitability and ability of the company to pay them interest and dividend etc. 4. Helpful in comparative analysis of the performance: With the help of......

Words: 867 - Pages: 4

Premium Essay

Historical Cost Accounting Decision Usefulness

...The Effect of ERP System Implementations on the Usefulness of Accounting Information Joseph F. Brazel Department of Accounting College of Management North Carolina State University Campus Box 8113 Raleigh, North Carolina 27695 Telephone: 919-513-1772 Fax: 919-515-4446 e-mail: joe_brazel@ncsu.edu Li Dang Department of Accounting College of Business Oregon State University Corvallis, Oregon 97331 Telephone: 541-737-6049 e-mail: li.dang@bus.oregonstate.edu October 2005 The authors thank the international ERP system supplier for providing them with the ERP system implementation data and Marianne Bradford and Jeff Wong for helpful comments. Funding for this research was partially provided by an NCSU Edwin Gill Research Grant. The Effect of ERP System Implementations on the Usefulness of Accounting Information ABSTRACT: ERP systems have become the system of choice for the majority of publicly traded companies and have radically changed the way accounting information is processed, analyzed, audited, and disseminated. In this study, we examine whether ERP system implementations have impacted the decision usefulness of accounting information. We find that ERP adoptions lead to a trade-off between increased information relevancy and decreased information reliability for external users of financial statements. After implementing the system, firms concurrently experience both a decrease in reporting lag and an increase in the level of discretionary accruals. Contrary to......

Words: 9697 - Pages: 39

Premium Essay

Historical Cost

...financial accounting according to the different measurement attributes, can be divided into historical cost accounting, current cost accounting, fair value accounting and other different models. Today is the leading and ruling position, or historical cost accounting model, although it faces challenges, can still be regarded as the basic pattern of financial accounting. 1, the historical cost accounting features 1, the basis for the past recognized. most important feature of the historical cost accounting is a past-oriented. From the basis of confirmation of view, the historical cost accounting is based on past transactions or events have occurred based on. Whether accrual or cash basis, are targeted to have occurred in terms of past transactions. The former caused a result of past transactions and the rights and obligations; the latter a result of past transactions caused by cash. Their common feature is based on transactions or events that have occurred in the foundation. 2, measured at historical cost. This is the essence of historical cost accounting. Assets, liabilities, costs measured at historical cost, provided that for the past history information associated with the lack of reality. 3, follow the decision of revenue realization and matching principle. double-entry bookkeeping has been created, through cost and revenue for the ratio to determine the income, has been the main features of accounting, and constitutes the entire accounting......

Words: 1457 - Pages: 6

Premium Essay

Historical Cost Accounting

...Limitations of Historical Costing in times of Inflation Historical Cost accounting and its significance History of Historical Cost Accounting Techniques of Historical Cost Accounting Conclusion References: 1 2 3 *** The impact of inflation comes in the form of rising prices of output and assets. As the financial accounts are kept on Historical cost basis, so they don't take into consideration the impact of rise in the prices of assets and output. This may sometimes result into the overstated profits, under priced assets and misleading picture of Business etc. So, the financial statements prepared under historical accounting are generally proved to be statements of historical facts and do not reflect the current worth of business. This deprives the users of accounts like management, shareholders, and creditors etc. to have a right picture of business to make appropriate decisions.  Hence, this leads towards the need for Inflation Accounting. Inflation accounting is a term describing a range of accounting systems designed to correct problems arising from historical cost accounting in the presence of inflation. The significance of inflation accounting emerges from the inherent limitations of the historical cost accounting system. Following are the limitations of historical accounting: 1. Historical accounts do not consider the unrealised holding gains arising from the rise in the monetary value of the assets due to inflation. 2. The objective of charging......

Words: 320 - Pages: 2

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

...Financial Accounting – Historical Cost Accounting Student Name: Richard Simpson B00580164 Total Word Count: Contents Page Executive Summary The purpose of this report is to analyse historical cost accounting providing information on the strengths and weaknesses, alternatives to historical cost accounting and current regulatory guidance on how to deal with the effects of inflation on the financial statements. This report has also considered and explained the following statement: “Historical cost accounting is used almost exclusively in practice but it is generally accepted that the resulting historical cost accounting financial statements suffer from a number of weaknesses.” 1.0 Introduction 1.1 – What is meant by historical cost accounting? The historical cost accounting model is a measure of value in accounting that allows, ‘transactions to be recorded in the accounts at the original price. An item then remains in the accounting records at that original price until disposal’ (Alexander and Britton, 2004) even though their value may have changed over time. Historical cost accounting or commonly referred to as ‘historical cost convention’ is the ‘practice of recording the historical cost of an asset as its cost on a balance sheet’ (financial-dictionary.thefreedictionary.com, 2012). For example, ‘assets are recorded at the amount paid to acquire them. Liabilities are recorded at the amount of proceeds received in exchange for......

Words: 321 - Pages: 2

Premium Essay

Advantages &Disadvantages

...Advantages and Disadvantages of Convention and Concept Advantages of accounting concepts, conventions and regulations. There are many advantages that accounting concepts have on financial statements. Four important accounting concepts that underpin the preparation of any sets of accounts one of which is going concern that helps an account to assume for any future problems that occur in a business. This helps companies to make future plans and gives them time to gather money to sort out any financial problems. Consistency also has an advantage in helping in accounting by users of accounts can make more meaningful comparisons of financial performance. Prudence helps investors sort out financial performance such as future problems and cost of the business before recognising any signs of profits. Accruals also help financial data to be useful for users by all business revenues and cost are recorded in the appropriate statements and at the appropriate time. Conventions also have many advantages in influences financial statements to be useful for investors. Separate entity is one example this convention seeks to ensure that all private transactions and matters relating to the owners are segregated from transactions that relate to the business. This is an advantage because owner’s transactions are kept private. Also they are not mixed with the business finance so that users can clearly see the business financial state. Also materiality is also an important convention in a......

Words: 327 - Pages: 2

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

Free Essay

Limitations of Historical Cost Accounting

...institutionalization of social reporting in western countries.1 Third it deals with the empirical fact of uncom European Second actors plete presents defined and subsequently reporting in western Europe, for an explanation. Western is hypotheses Europe here as the 16 European countries with 1 million inhabitants and over with the inclusion of Luxembourg, but excluding the former some And social is conceived reporting traditions connected with as a general term the labels "social diffusion of social CMEA-countries. the research comprising "level of living", indicators", "quality of life", "social well-being", "standard of living" and including also the system approaches as "social matrices" and "satellite accounts" 1973: p. 261). accounting (see Zapf, On the whole this paper is something like a "sociology of societal data" (Albert D. Biderman), Social ?1993 Indicators Research Klu wer Academic whose 29: 1?62, Publishers. main 1993. Printed purpose is according to Biderman in the Netherlands. 2 FRANZ ROTHENBACHER of political, and other institutional (1966: p. 73) the "identification for gaps and low standardization barriers in data about responsible crucial social phenomena". The origins of social reporting can at least be seen in three points: an expert the United Nations in 1954 requested Firstly already to explore the possibilities to conceptualize commission and measure what was called then the "standard of living". This mission was......

Words: 7633 - Pages: 31

Premium Essay

Advantages and Disadvantages of Outsourcing

...Advantages and Disadvantages of Outsourcing Webster University PROC 5000 Abstract This paper examines how outsourcing affects a business positively and/or negatively. During this paper I will discuss the advantages and disadvantages of outsourcing. There are many reasons why a company may choose to outsource a particular function of their business. The end result in mind is saving time and/or money. Before a company considers outsourcing it should first do a competitive analysis of its company before initiating an outsourcing analysis. The company should also consider the advantages and disadvantages of outsourcing. The advantages are the following: reduction in critical resources, provides ability to focus on core business, yields cost savings, provides flexibility, reduction overhead costs, etc. The disadvantages are as follows: loss of managerial control, hidden costs, threat to security and confidentiality, quality problems, tied to financial well-being of another company and bad publicity and ill-will. When you think of outsourcing do you think of a call center in India or jobs be taken away from Americans and sent overseas? Well, since the Industrial Revolution, companies have wrestled with how they can take advantage of their competitive advantage to increase their profits. The standard for majority of the 20th century was a large integrated company that can “own, manage, and directly......

Words: 1793 - Pages: 8

Premium Essay

Advantages and Disadvantages of the Ehr

...Advantages and Disadvantages of the EHR Over the historical decade, every major business invested heavily in computerization. Comparative to a decade ago, today more Americans buy airplane tickets and check in to air flights online, buy things off the internet, and some people earn degrees online. In spite of these developments in our civilization, many patients are given handwritten prescriptions, and not many patients are able to email their doctor or even schedule an appointment to see a physician without speaking to a live receptionist. Electronic health record (EHR) systems has changed the healthcare system from a mostly paper-based industry to a computerized system to assist providers in providing higher quality of care to their patients. The Health Information Technology for Economic and Clinical Health (HITECH) Act of 2009, which is part of the American Recovery and Reinvestment Act (ARRA) (aka “stimulus package”), was signed into law with an unambiguous purpose of incentivizing providers to adopt EHR systems. The HITECH Act requires that providers adopt EHRs and use them in an eloquent way, meaning using certain EHR functionalities associated with error reduction and cost containment. Some advantages of technology in our society today regards clinical, organizational, and societal outcomes. Clinical outcomes consist of enhancements in the value of care, a decrease in medical mistakes, and other advances in the number of patients that describe the relevance......

Words: 697 - Pages: 3