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Advantages and disadvantages of historical cost accounting, alternatives to historical cost
accounting
2.1 Introduction
Accounting concepts and conventions as used in accountancy are the rules and guidelines
by which the accountant lives. The historical cost accounting convention 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.
The historical cost accounting 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 moneys worth, received or paid to complete the transaction.
Historical costs
Historical cost is a generally accepted accounting principle requiring all financial
statement items be based upon original cost. Historical cost means what it cost the
company for the item. It is not fair market value. This means that if a company purchased a
building, it is recorded on the balance sheet at its historical cost. It is not recorded at fair
market value, which would be what the company could sell the building for in the open
market.
Criticisms of the historical costs method
Historical cost method, over a period of time has been subject to many criticisms,
especially as it considers the acquisition cost of an asset and does not recognise the current
market value. Historical costs is only interested in cost allocations and not in the value of
an asset. While it tells the user the acquisition cost of an asset and its depreciation in the
following years, it ignores the possibility that the current market value of that asset may be
higher or lower than it suggests.
Another main criticism of historical accounting method is its obvious flaws in times of
inflation. The validity of historic accounting rests on the assumption that the currency in
which transactions are recorded remains stable, i.e. its purchasing power remains the same
over a period of time. Another main point with regards to inflation is rise in prices for an
asset. An asset purchased at a point in time may be expensive in future. The traditional
accounting principles record all assets at an original cost and continue to use these historic
figures throughout the assets life, while economists make a more intelligible assumption
that money has a time-value attached to it. The economists approach is broadly embraced
in the corporate finance model whose objective is centred on value creation for the
shareholders.
In addition effects of inflation maynot be the same for all the companies in the market and
