Question:
Discuss about the Historical Cost and Current Cost Accounting.
In the area of accountancy, Accounting Measurement is considered as an important area. Accounting Measurement refers to the process of computing various financial or economic activities in terms of money, hours and others units. In the other words, accounting measurement represents various units of measurable elements that are largely used for the comparison and evaluation of different kinds of accounting data. It can be seen that business organizations all over the world use different basis for accounting measurement. Some companies use money as the basis of accounting measurement and some companies use units as the basis of accounting measurement (Kanodia & Sapra, 2016). For example, it can be said that a single company can use both money and units for accounting measurement. The company can record the monthly sales of them based on money that is $50,000. The same company has the option to recode the monthly sales based on units that is 25,000 units$2 per unit.
Thus, from the above discussion, it can be observed that accountants have the option to quantify accounting based on money; at the same time, they also have the alternative option to record accounting based on units, number of labor hours, number of created jobs and others. There is a major advantage of using different types of bases for accounting measurement as it provides the accounting managers of the companies with better view of the overall financial health of the companies. For the ease of understanding, another example can be used. A business organization has recorded $100,000 as the monthly sales of them; this will be considered as accounting measurement in the form of US dollars. However, the organization also has the option to record their monthly sale based on hour’s world or jobs created or others. However, it needs to be mentioned that business organizations need to take accounting measurement decisions after considering all required factors; otherwise, it can increase the capital requirements of the business organizations (Barth, 2013).
All over the world, Historical Cost Accounting is known as Conventicler Accounting. According to the techniques of historical cost accounting, all the organizational assets except inventory are recorded in the books based on their historical cost; but the liabilities of the organizations are recorded in the books based on their payable value. In addition, the expenses are recorded based on historical cost while incomes are recorded based on current prices. It can be seen that historical cost accounting has received many criticism for various reason and at the same time, has also received many praises. The following discussion shows the main arguments for and against the process of historical cost accounting.
As per the techniques of historical cost accounting, deprecation is charged on the fixed assets of the organization. Under this process, the total amount of depreciation of the assets over the full lifetime is equal to the original cost of the assets in the absence of any scrap value. Thus, there should not be any problem in the valuation. However, over the whole lifetime of the assets, there can be reduction in the market prices of the assets due to various reasons like inflation and others. Many authors argue that historical cost accounting undervalues current or market price of the assets and thus, it does not consider the impacts of monetary price changes. However, many accountants have stated for the historical cost accounting that it is the reluctance of organizational accountant to consider the market value of the assets. They have found by stating that the reluctance of the accountants to consider the market price affects the share price of the companies (Ellul et al., 2015). Many authors have mentioned that the adoption of historical cost accounting diminishes the possibility of the manipulation of data. This can be considered as one major advantage of historical cost accounting.
Under the process of historical cost accounting, cost of inventory is recorded based on the market price and sales are shown based on the current purchasing power of money. Thus, many authors argue that due to this process, the profit shown in the financial statements of the companies does not correctly show the actual status of the company’s wealth. The main reason is that historical cost accounting does value the inventory based on their current market value. This can be consider a major limitation. However, by arguing for the historical cost accounting, many authors have mentioned that historical cost accounting put major focus on actual transactions rather than projections as it has association with better organizational control. Under the process of historical cost accounting, there is not any scope of personal partiality on the part of the accountants. Under the process of historical cost accounting, the figures represent the actual value of the fixed assets of the companies (Drury, 2013). Hence, based on the discussion, it can be said that people have argued both for and against the adaptation of historical cost accounting in the companies.
Many authors argue on the fact that historical cost accounting put too much emphasis on the income and profitability of the companies. This particular process leads to the distortion of real flow of cash in the financial statements and for this reason, the users of financial statements face great difficulties in the application of financial information for decision-making process. Many accountants have argues that the financial statements prepared based on the historical cost accounting put emphasis on the figures of historical cost (Jaijairam, 2013). On the same context, many authors have also argued on the fact that the application of historical cost accounting provides the financial managers with many alternatives in the recognition, reporting and evaluation of the economic information of the companies. In addition, with the help of historical cost accounting, the organizational managers become able to project the future operational costs. Further arguments on historical cost accounting shows the objective of historical cost accounting is to make the users aware the cost of the products. Thus, it can be seen that there are both advantages and disadvantages.
Apart from the above issues, many arguments have been made on historical cost accounting that the balance sheet of the companies based on the techniques of historical cost accounting fails to show the details about all the organizational resources. The main reason is the recorded lower value of organizational assets due to not consideration of current market value. Thus, the presentation of assets in the balance sheet will not be able to reflect the actual financial condition of the companies (Costa & Guzzo, 2013). However, many authors have also stated that under the process of historical cost accounting, the organizational accountants have the authority to protect the credibility of organizational data with the help of interior modification. Critics of historical cost accounting all over the world have admitted the fact that the adoption of historical cost accounting diminishes the likelihood of manipulation of financial and accoutering data. Under the system of historical cost accounting, it is difficult to manipulate accounting data as proper invoices, receipts, vouchers, cash memos and others support them. This can be considered as the major advantage of historical cost accounting.
Current Cost Accounting is also known as Market Value Accounting. The accounting procedure under current cost accounting is different from the accenting under historical coat accounting. In this context, it needs to be mentioned that the assets are measured under current cost accounting based on the replacement costs of the assets. In this process, accountants need to do an accounting adjustments and this adjustment is called ‘market-to-market’ adjustment. There are many arguments against and for the process of current cost accounting. The following discussion shows the arguments against and for current cost accounting.
Under the techniques of current cost accounting, accountants make the valuation of organizational assets and liabilities based on the market price of them. Based on this above statement, most of the accountants have made argument that current cost accounting is the most relevant process of accounting measurement as the accountants of the companies have to consider the up-to-dated financial information regarding the assets and liabilities. At the time of the valuation of assets and liabilities, the accountants need to consider different aspects of the market like inflationary adjustments, increase or decrease in the prices of organizational assets and others. As a result of all these consideration, the financial statements of the companies shows the correct value of the assets and liabilities (Gynther, 2014). Thus, the financial statements of the companies reflect the correct financial health. However, many other accountants and authors also make argument on the fact that the process of current cost accounting is unreliable as the market volatility affects the valuation of assets and liabilities of the organizations. Due to the volatility in market, frequent fluctuations can be seen in the prices of organizational assets. Thus, the inclusion of one price uses to become irrelevant in the market on a quick basis. Due to this, the value of assets and liabilities in balance sheets does not reflect the actual values of the profits. This is a major disadvantage of current cost accounting.
At the time to make the investment decisions, the investors and creditors highly prefer the current cost accounting process for the companies as it takes into account the market prices of assets and liabilities. As per the arguments of many authors, this particular aspect is one of the major advantages of current cost accounting. With the help of current cost accounting, the investors and creditors of the companies can get effective and correct financial information in order to make effective investment-decisions. Under the techniques of current cost accounting, companies provide the investors and creditors with the information about the market value of assets and liabilities on the reporting date, changes in the market value of assets along with their components and others so that they can take effective investment decisions. All these aspects provide great assistance to the investors and creditors under current cost accounting. However, some of the authors have argued that the implementation of current cost accounting creates negative impact on the investors and creditors of the companies. The frequent changes in the prices of assets of the companies makes the investors and creditors de-motivated towards the investment in those companies (Shepherd, 2015). Due to the frequent changes in asset prices, investors consider the financial position of the companies vulnerable. The investors consider that the financial statement of the companies do not reflect the actual financial health of the organizations.
With the help of the adoption of current cost accounting, accountants of the companies can take into consideration the changes in the price of dollars. For this reason, the organizational accountants can measure the impact of price in dollar changes on the assets and liabilities of the companies. Large number of accountants all over the world considers this aspect as a major advantage of current cost accounting (Bonin, 2013). However, there are many arguments that this particular aspect has some major negative aspects on the financial statements of the companies. Due to the fluctuation in the price of dollars all over the world, the prices of assets in the companies get affected. In this process, it becomes difficult for the business organizations to changes the valuation of organizational assets and liabilities. It is also difficult for the investors and creditors to make investment decisions in those particular companies. This can be considered as one major disadvantage of current cost accounting.
It needs to be mentioned that the adoption of current cost accounting largely helps in the recognition of various risk factors related to the assets and liabilities of the companies. As per the earlier discussion, it can be seen that the various techniques of current cost accounting helps the business organizations to record the correct asset value in the financial statements. Thus, from the analysis of the financial statements of the companies, the investors can recognize the financial risk factors (Drucker, 2017). This can be considered as a major advantage of current cost accounting. However, many accountants oppose this advantage. According to them, there are many instances where the financial statements of the companies fail to reflect the correct value of the assets and liabilities of the companies. In those situations, it is difficult for the investors and other users of financial statements to judge the various risk factors from the analysis of financial statements. This can be considered as a major disadvantage of current cost accounting.
The main aim of this report is to analyze and evaluate various aspects of current cost accounting and historical cost accounting. Various arguments have been made both for and against these two types of cost accounting system. The first part of this study shows that accounting measurement is the process of measuring accounting based o money, labor hour, units and others. This part of this report shows that business organizations always have the option to shows the accounting in the form of the above-mentioned alternatives. However, at the time of selecting the basis of accounting measurement, it is required for the organizational managers to consider all the necessary facts as the success of accounting measurement largely depends on them.
From the above discussion, it can be seen that accountants all over the world have their views both against and for the practice of historical cost accounting. Many authors consider the fact that the techniques of historical cost accounting have the tendency of undervalues the current market price of the fixed assets. However, some authors have explained that it is the reluctance of the managers not to take the present values. In addition, it can also be seen that under the process of historical cost accounting, correct value of organizational profit cannot be obtained. Opposing this statement, some of the accountants have mentioned the fact that the techniques of historical cost accounting prevent the scope of manipulation of accounting data and information. Thus, it can be seen that there are both advantages and disadvantages of the techniques of historical cost accounting. Accountants need to consider all the necessary aspects before adopting historical cost accounting.
The same trend can be seen in the case of current cost accounting as arguments both for and against it can be seen. Most of the accountants have mentioned that current cost accounting takes into consideration the market price of the assets and liabilities as it helps in showing the correct profit and values in the financial statements of the companies. However, one major negative effect of current cost accounting is the consideration of market volatility. The adoption of current cost accounting considers the fluctuations in the prices of assets. For this reason, the values of assets in the financial statements do not reflect the actual financial conditions of the companies. However, under the techniques of current cost accounting, the investors become able to judge the market risk on the assets of the organizations. Thus, based on the above discussion, it can be mentioned that the techniques of current cost accounting has both negative and positive arguments.
References
Barth, M. E. (2013). Measurement in financial reporting: The need for concepts.
Bonin, H. (2013). Generational accounting: theory and application. Springer Science & Business Media.
Costa, M., & Guzzo, G. (2013). Fair value accounting versus historical cost accounting: A theoretical framework for judgement in financial crisis. Corporate Ownership & Control, 11(1), 146-152.
Drucker, P. F. (2017). The Theory of the Business (Harvard Business Review Classics). Harvard Business Press.
DRURY, C. M. (2013). Management and cost accounting. Springer.
Ellul, A., Jotikasthira, C., Lundblad, C. T., & Wang, Y. (2015). Is historical cost accounting a panacea? Market stress, incentive distortions, and gains trading. The Journal of Finance, 70(6), 2489-2538.
Gynther, R. S. (2014). Accounting for Price-Level Changes—Theory and Procedures: Pergamon International Library of Science, Technology, Engineering and Social Studies. Elsevier.
Jaijairam, P. (2013). Fair value accounting vs. historical cost accounting. The Review of Business Information Systems (Online), 17(1), 1.
Kanodia, C., & Sapra, H. (2016). A real effects perspective to accounting measurement and disclosure: Implications and insights for future research. Journal of Accounting Research, 54(2), 623-676.
Shepherd, R. W. (2015). Theory of cost and production functions. Princeton University Press.
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