Limitations of Historical Cost Accounting

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 money's worth or the fair value of the consideration given to acquire them at the time of their acquisition , received or paid to complete the transaction.

Limitations of Historical Cost Accounting include:

Control Consumption Taxation Valuation

Control

The prime objective of the preparation and publication of regular financial reporting is:

Provide information for the shareholders about the progress of the company to be assured that the company achieved its objectives.

And to be assured that the management uses the company recourses in effective way as the shareholders wish.

StewardshipIs narrowly defined to cover simply the

reporting by directors to shareholders of how they have used shareholders funds.

If the board of directors uses the method of stewardship then:

It is possible to argue that historical cost accounting is reasonably adequate.

A historical cost balance sheet lists the assets of the company and the liabilities on the company; however it will not identify all the assets, as it will usually omit many intangible assets such as the skill and knowledge of the employees.

control Historical cost accounts, in general,

simply show the acquisition cost or the depreciated historical cost of a company’s assets and not their current value, let alone the value of the company as a whole. So historical cost accounting do not provide an absolute measure of success of the company.

control The historical cost accounts are most

unhelpful when it comes to the comparison of performance because the inflation which means general increase in price or fall in value of money affect different companies in very different way and the problem is not just inflation but includes the treatment of changes in relative price.

Consumption

Consumption Empirical evidence suggests that

companies' dividends are related to the level of the reported profit.

The concept of capital maintenance based on historical cost accounting principles has proved to be a dangerous benchmark when used to assess the amount which a company can pay out by way of dividend or through taxation.

Consumption Distribution decisions should be made

on the basis of consumption needs and perceived future investment opportunities inside and outside the company, and in many cases it would be sensible not to restrict distribution to profits.

Taxation

Taxation The company tax charge is based on its

accounting profit, the higher the amount that will be paid in tax.

The historical cost accounting does not constitute a suitable basis for the computation of the taxation obligations of business.

Taxation The use of historical cost accounting as

the basis for taxation means that in period of rising prices the proportion of the increase in company wealth which is taken by taxation may be very much larger than that which is implied by the nominal rate of taxation.

Taxation The rapid and extreme inflation of the

mid-1970 made government and others very much aware of the inadequacy of historical cost accounting for the purpose of taxation.

Valuation

Valuation The knowledge of historical cost of a

company asset will not be of much help in assessing the value of a company or its shares in a business; hence, it is better using current value principle to valuate the company.

Alternatives to Historical Cost Accounting

Replacement costs. current cost accounting. Exit price method.

The End

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