Historical Cost Essay

2623 words - 11 pages

The historical cost accounting is an accounting technique that values an asset for balance sheet purposes at the price paid for the asset at the time of its acquisition. It is usually used in combination with other measurement bases. For example, inventories are usually carried at the lower of cost and net realizable value, on the other hand marketable securities are usually carried at market value, and entities prefer to carry pension liabilities at their present value.
The main advantage of using historical cost accounting model is its simplicity and certainty. Most entities know what they have paid for the assets when they purchased them. Similarly they also know what proceeds they ...view middle of the document...

A transaction can be arm’s length transaction if the parties act independently and have no relationship to each other.
intangible assets that had never been recognized now had to be separately identified and reported in a business combination. The statement also notes that “judgment is required in estimating the period and amount of expected cash flows,” and that these judgments should be consistent with the objective of measuring fair value. it may be necessary to use the present value of discounted cash flows technique presented in SFAC 7 when a market value cannot be used to establish a reasonable value.
The inflation issues and current market valuation are ignored in this method. Thus, it might ‘not provide useful and relevant information for decision making’ 
Current cost accounting attempts to provide more realistic book values by valuing assets at current replacement cost, rather than the amount actually paid for them. This contrasts with the usual historical cost approach. It is usually calculated by adjusting the historical cost for inflation, in addition to the usual adjustments such as depreciation.
The drawback of current cost accounting is it is more complex than historical cost accounting, and attempts to implement it tend to create controversy over what adjustments are appropriate. 
The problems that current cost accounting attempt to solve are obviously linked to inflation. Interest in inflation accounting tends to be greatest when inflation is high, and low when inflation is low.
Current costs are claimed to have several advantages over the historical cost concept. The current cost represents the amount the firm would have to pay currently to obtain the asset or its services; therefore, it represents the best measure of the value of the inputs being matched against current revenues for predictive purposes. It permits the identification of holding gains and losses, thus reflecting the results of asset management decisions and the impact of the environment on the firm not reflected in transactions. The current cost represents the value of the asset to the firm if the firm is continuing to acquire such assets and if value has not been added to the asset by the enterprise. The summation of assets expressed in current terms is more meaningful than the addition of historical costs incurred at different time periods. It permits the reporting of current operating profit, which may be used to predict future cash flows.
One of the disadvantages of the current cost concept is that some objectivity has been lost; unless the assets currently sold in the market are identical in all respects to the assets held, some subjectivity must be applied in transferring current exchange prices to the owned assets. Also,current costs might not represent the current value to the enterprise. If the firm were required to pay the current costs, it might be economically advantageous to acquire other asset forms instead. The present value of the benefits to...

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