Premium Essay

Limitations of Historical Cost

In: Business and Management

Submitted By adathree2009
Words 896
Pages 4
Historical-cost accounting

Is a system of accounting based on the principle that assets should be valued at historical cost or historical cost is the original monetary value of an economic item.

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.

It is relaxed to some extent by such practices as the valuation of stock at the lower of cost and net realizable value and, revaluation of fixed assets.

The advantages of historical-cost accounting are that it is relatively objective, easy to apply, difficult to falsely manipulate, and suitable for audit verification.

In times of high inflation, however, the results of historical-cost accounting can be misleading as profit can be overstated, assets understated in terms of current values, and capital maintenance is only concerned with the nominal amount of the capital invested rather than its purchasing power.

Because of these defects it is argued that historical-cost accounting is of little use for decision making, but attempts to replace it with such other methods as current-cost accounting have failed.

Company legislation sets out the rules for the application of historical-cost accounting to financial statements. Companies may also choose to use alternative accounting rules based on the modified historical-cost convention, in which certain assets are included at revalued amounts.

The problems that can be encountered when users rely on financial statements prepared under the historical cost conversion of their information need.

Financial statements prepared on the historical cost basis do not necessarily lead to a true and fair presentation of…...

Similar Documents

Premium Essay

Limitation

...Limitation Although this market research has been finished already, there are still some limitations that cannot be avoided. Firstly, in terms of questionnaire design, the total amount of questions in the questionnaire maybe too large, and it costs respondents about 3 minutes to finish all of them. Especially when they saw the 10 tables, many of them showed their impatience to finish the questionnaire. In addition, some respondents cannot quite clearly understand what they should do on the tables. Thus, it indicates that the table questions may not be so well designed and made respondents confused about that. It would be better if the table questions could be simplified. Secondly, regarding respondents, many people were not willing to respond questions through the whole process of conducting the survey. It may result in some problems when analyzing demographic data. According to the results, it is obvious that the ages of the respondents are focused on 18 to 35. It is difficult to get some feedbacks from people in other ages, especially elderly people and people with a young baby. Thus, their purchase preference and intention are not clear in the analysis. Moreover, some respondents finished the questionnaire in a hurry and they even did not read the questions clearly. Among all the questionnaire paper, there are approximately one fourth of the respondents did not finished all the questions required. Thirdly, many respondents consuming in Wal-Mart have never heard about its......

Words: 344 - Pages: 2

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

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

...years’ ratios, estimates for future can be made. In this way these ratios provide the basis for preparing budgets and also determine future line of action. Limitations of Ratio Analysis In spite of many advantages, there are certain limitations of the ratio analysis techniques and they should be kept in mind while using them in interpreting financial statements. The following are the main limitations of accounting ratios: 1. Limited Comparability: Different firms apply different accounting policies. Therefore the ratio of one firm can not always be compared with the ratio of other firm. Some firms may value the closing stock on LIFO basis while some other firms may value on FIFO basis. Similarly there may be difference in providing depreciation of fixed assets or certain of provision for doubtful debts etc. 2. False Results: Accounting ratios are based on data drawn from accounting records. In case that data is correct, then only the ratios will be correct. For example, valuation of stock is based on very high price, the profits of the concern will be inflated and it will indicate a wrong financial position. The data therefore must be absolutely correct. 3. Effect of Price Level Changes: Price level changes often make the comparison of figures difficult over a period of time. Changes in price affects the cost of production, sales and also the value of assets. Therefore, it is necessary to make proper adjustment for price-level changes before any comparison. ......

Words: 867 - Pages: 4

Premium Essay

Historical Cost Accounting Decision Usefulness

...implementations can potentially increase the likelihood of financial statement management. 3 The remainder of this paper is organized as follows. The next section discusses the background and related research and develops hypotheses. Section III discusses the sample selection and the research design. Section IV presents results and Section V offers conclusions and implications. II. BACKGROUND AND HYPOTHESES DEVELOPMENT ERP System Implementations The decision to implement an ERP system represents a significant investment of firm resources. ERP systems, sold by vendors such as SAP AG and Oracle Corporation, typically cost $15 million and implementations take, on average, 21 months to complete (O’Leary 2000). The implementation costs rise to upwards of $100 million for large international corporations (Davenport 1998). In addition, substantial annual costs are incurred to maintain and periodically update the system. Over the past decade, corporations have experienced both successful and unsuccessful ERP implementations and the benefits, complexities, and risks of ERP systems have been documented in the popular press (e.g., Bartholomew 1997). Recently, the majority of ERP systems press coverage has been devoted to Oracle’s acquisition of rival PeopleSoft Inc. and its battle with industry leader SAP AG for market share (e.g., Bank and Clark 2004; Bank and Boslet 2005). Empirical research related to ERP system implementations can be divided into three research streams.......

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

Limitations of Historical Costing in Times of Inflation

...of some particular limitations of historical cost accounting in terms of its ability to cope with various issues associated with changing prices; ◆ be aware of a number of alternative methods of accounting that have been developed to address problems associated with changing prices; ◆ be able to identify some of the strengths and weaknesses of the various alternative accounting methods; ◆ understand that the calculation of income under a particular method of accounting will depend on the perspective of capital maintenance that has been adopted. Opening issues Various asset valuation approaches are often adopted in the financial statements of large corporations. Fixed assets acquired (or perhaps revalued) in different years will simply be added together to give a total euro value, even though the various costs or valuations might provide little reflection of the current values of the respective assets. Issues to consider: (a) What are some of the criticisms that can be made in relation to the practice of accounting, wherein we add together, without adjustment, assets that have been acquired or valued in different years, when the purchasing power of the euro was conceivably quite different? 121 Buy this file: http://www.download-it.org/learning-resources.php?promoCode=&partnerID=&content=story&storyID=19988 122 CHAPTER 5 ACCOUNTING FOR CHANGING PRICES (b) What are some of the alternative methods of accounting (alternatives to historical cost accounting) that......

Words: 1269 - Pages: 6

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

Advantages and Disadvantages of Historical Cost Accounting

...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......

Words: 313 - Pages: 2

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

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

Limitations

...Limitations and constraints of marketing In this task I will be explaining the laws that focus on protecting the customers when they are buying a product or service from things such as fraud and identity theft. There are several limitations and constraints in the consumer law that help the customers understand their legal rights and they protect them. Laws are constantly changing to ensure that businesses do not take advantage of their consumers. Sales of goods act 1979 This law states that; the goods must be fit for purpose, which means that for everyday purpose, and also for for any specific purpose that can be agreed with the seller at the time of purchase. The goods must also match any sample or images that are visible to the consumers, such as in brochures and leaflets also the description of the product must match the product. The goods that you buy must be in perfect working condition. An example of where the act has been broken could be; A seller who was a specialist in contemporary art and they offered a paining and this individual claimed it to be by the artist who was German. The buyer makes it clear that he was not an expert on German paintings; although the seller should examine the painting himself before putting the painting up for sale. The buyer brought the painting which later on turned out to be forgery which is in fact illegal. The court of appeal held that he could not cover his purchase price from the seller since he had not relied......

Words: 756 - Pages: 4

Free Essay

Limitations of Historical Cost Accounting

...1988-89; 6, 1989-90: 7, 1. 1978 ?. 1987 1. 1979 1. 1979 plunncd 1983 1991? 1960-1970(1976) 1986 1960-75; 1960-78; WHO UNESCO FAO UNRISD OECD European Communities (EC) Council of Mutual Economic Assistence (CMEA) In 1989 available 1960-1 1991 was planned for the end of th online internally. APPROACHES The International Labour IN SOCIAL REPORTING 7 employment, and expenditures, conditions, wages security, working the two serial publications Yearbook and salaries. The ILO publishes of and Bulletin this there Labour Statistics of Labour Statistics. Besides social income are published a plurality of ad-hoc-statistics. In 1979 ILO published the on Household Income and Expenditure third edition of the compendium In 1990 a historical is until now without Statistics which successor.3 on population censuses was and occupation 1945?1989 compendium published. ardization An of field of activity of the ILO is the stand important labour statistics. The ILO data base on labour statistics will be available on diskette in the neartime. on explicit programme are but the central Its publications an (ILO) did not develop Organization indicator systems or of level of living-research. source for the domains and Agricultural in 1979 a (FAO) accepted Organization Programme of Action for Agrarian Reform and Rural Development. ? on Agrarian and Rural Development (World Conference Reform In the frame of the implementation of this programme WCARRD). a socio-economic......

Words: 7633 - Pages: 31

Ирландия | American Nightmare 4 Les Origines 1080p TrueFrench Film Torrent complet en français | Page 138