• Join over 1.2 million students every month
  • Accelerate your learning by 29%
  • Unlimited access from just £6.99 per month

'Historic cost accounting is the worst possible accounting convention, until one considers the alternatives.'

Extracts from this document...

Introduction

AF 301 Financial Accounting II Historical Costing Name: Shengheng Guan Student No.: M207952 14 December 2004 Table of Contents 1. INTRODUCTION ...................................................................... 3 2. THE LIMITATIONS OF HISRORICAL COST ACCOUNTING ............. 3 3. THE ALTERNATIVES UNDER CONSIDERATION 3.1 CURRENT PURCHASING POWER ACCOUNTING ......................... 4 'Historic cost accounting is the worst possible accounting convention, until one considers the alternatives.' 1. INTRODUCTION The most commonly encountered accounting convention is the "historical cost accounting". The creation of this accounting convention can be traced to the work of a Franciscan monk by the name of Pacioli in the year 1494. Historical cost accounting sets prices on the basis of original costs, where the cost of assets is measured by their depreciated historic cost. Therefore, no account is taken of changing prices in the economy under historical cost accounting. Over time, numerous other accounting theories have been developed by a number of well respected scholars and historical cost accounting has been criticised on the basis that it has too may shortcomings, with particular emphasis on its failing to provide useful information in times of rising prices. However, many of the proposed methods have been rejected by the accounting profession. In the following section we mainly consider and assess the advantages and limitations of historical cost accounting with respect to some other prescriptive theories of accounting that have been advanced by various people. A final section concludes, summarise the findings and introduce some directions for future research. 2. THE LIMITATIONS OF HISTORICAL COST ACCOUNTING As the traditional method of accounting, historical cost accounting has been used with variations over the past centuries. ...read more.

Middle

However, because the general price index is applied to all assets, this will rarely be the case. Third, various studies have failed to generate support to prove that information gathered under CPPA is relevant for decision making. 3.2 CURRENT COST ACCOUNTING Following the initial acceptance of current purchasing power accounting in 1970s, the accounting profession tended to favour current cost accounting, which is a more recent idea and is more complicated compared with historical cost accounting. It addresses many of the problems associated with historical cost accounting, particularly in times of inflation. Notable advocates of this approach have included Paton, Edwards and Bell. In 1980 the Accounting Standards Committee issued SSAP 16 which required supplementary disclosure of current cost data (SSAP was withdrawn in 1985). The main asset valuation bases used within current cost accounting are replacement cost, net realisable value (i.e. the net present value of the particular asset) and economic value. Depending on the circumstances, a choice have to be made concerning which base to use for valuing a particular asset at its current value. 3.2-1 The replacement cost (RC) model is proposed by Edwards and Bell. They adopt a physical capital maintenance approach to income recognition and assess income and value by reference to entry costs or current replacement costs of materials and other assets utilised within the business entity. In short, it treats holding gains or losses as operating income, which represents the difference of realized revenue and the replacement cost of the asset in question. This approach is considered to be generating a measure of income that represents the maximum amount that can be distributed, while maintaining operating capacity intact. ...read more.

Conclusion

Alternative models of accounting might not be favoured by analysts either. The accounting profession, like some researchers, questioned the relevance of the accounting information adjusted to take account of changing prices particularly in times of lower inflation. As mentioned earlier in this essay, there is some evidence that information might not be relevant to the decision making processes of those parties involved in the capital market. Besides, accounting standard setters are concerned that a dramatic change in the accounting conventions might cause widespread disruption and confusion in the capital market and therefore might not be in the public interest. It has also been speculated that the adoption of a new method of accounting could have consequences for the amount of taxation that the government ultimately collects from businesses. CONCLUTION The purpose of this essay was to assess the historical cost accounting and its alternatives. As we have seen, historical cost accounting has a number of drawbacks particularly in times of rising prices. Its two most widely accepted alternatives, current purchasing power accounting and current cost accounting, set out to solve the problem. Current purchasing power accounting uses historical cost accounting as basis along with the price index. Its main attraction lies in its ease to implement and less costly. Under current cost accounting there are two types of accounting methods: replacement cost accounting and exit price accounting. Replacement cost accounting differentiates operating profit from holding gains and losses and uses the business profit to show how the entity has gained in financial terms from increase in cost of its resources. Exit price accounting The method of accounting predominantly used today is based on historical cost accounting. Hence the accounting profession and reporting entities have tended to maintain the support for this approach. ...read more.

The above preview is unformatted text

This student written piece of work is one of many that can be found in our GCSE Accounting & Finance section.

Found what you're looking for?

  • Start learning 29% faster today
  • 150,000+ documents available
  • Just £6.99 a month

Not the one? Search for your essay title...
  • Join over 1.2 million students every month
  • Accelerate your learning by 29%
  • Unlimited access from just £6.99 per month

See related essaysSee related essays

Related GCSE Accounting & Finance essays

  1. Comsat case

    award its stockholders with a reasonable return on equity given the company's business risk, it will have a directly adverse effect on the firm's earnings, reducing the availability of funds for system reinvestment. Eventually, it would also have a negative impact on Comsat's ability to raise capital from investors because

  2. Accounting Concepts and Conventions

    the sale of 20 pairs of trousers against the cost of �100 for acquiring them The company only sold 18 pairs of trousers. It would have been incorrect to charge her profit and loss account with 20 pairs of trousers, as 2 were left over If the company's intention of

  1. International Accounting Standard.

    They are also expected to be used during more than just one accounting period. In order to describe the nature and purpose of the document containing IAS 16 it is necessary to summarize its contents. The document implies that property, plant and equipment (PPE), should be recognised when (a)

  2. This report has been produced as evidence for Unit 9 - 'Financial Services' - ...

    have built up into a regular income to see you through your retirement. It works broadly like this: 1. You retire. 2. You take the money in your PPP, AVC or Defined Contributions occupational pension fund and use it to purchase an annuity, either from the company with which you

  1. International Accounting Standarts

    Therefore the systems served for different reasons and the form and content differ. 2.1 The HGB Accounting Standard The HGB is the oldest of the three common accounting standards (HGB, IAS and US-GAAP).It was established in the year of 1900 and not changed much since that time (about 100 years).

  2. Harmonisation of accounting standards in Europe

    the European Union, to reduce these costs by being encouraged to a change in the financial reporting system. However for smaller companies the benefits of harmonisation might not be as large as for the multinational businesses, which have to pay higher costs in the implementation of the harmonisation.

  1. "If management accountants are to remain useful to the organisations within they work, they ...

    An increase in cost of products were passed on to customers, organisations had diminutive incentive to maximise efficiency and improve management practises or minimise cost. However during 1980s competitors from overseas gained access to domestic markets. This caused organisations to manufacture new products of a higher quality at a lower

  2. A Career In Accounting 2 A Career In AccountingManagement accounting ...

    Coordinates the resolution of accounting system issues arising from factors such as changes in legislation, regulation, and accounting standards. Planning, analyzing and determining cost benefit relationships. Responsible for monitoring all operations in the accounting and finance branch, providing technical assistance and guidance to management officials and technicians engaged in the

  • Over 160,000 pieces
    of student written work
  • Annotated by
    experienced teachers
  • Ideas and feedback to
    improve your own work