Historical Cost Accounting: Criticisms and Alternatives

historic woo be Criticisms and AlternativesIntroduction report is a centre and communication of m nonp beiltary information about frugal practiseivities to fire persons.1The primary role of account is to provide an effective measurement and reporting system which is also story information system for finding making.The corporate form of a large line of merchandise has created dissolution of business ownership and control. Outsiders of an organization, usually, dont possess first-hand knowledge of the day-to-day running and condition of the business, which makes them dependant, to meet about extent, on bill reports for information.Management is considered to be a comp some(prenominal) insider, who has find to the important information about a company that provoke impact its stock legal injurys or faculty influence investors decisions. This creates conflict of sake as company insiders argon in a position to exploit a professional or official capacity in some mien for their personal or corporate benefit.International Accounting Standards Committee (IASC) persuasion that investors need information on risk and return employees atomic number 18 interested in their stability and profitability lenders be concerned with loans and interest to be paid when due suppliers and different traders extremity to know whether owed amount pass on be paid or not and customers are interested in continuance of the enterprise.2Information is needed by diverse users to be equal to decide when to buy, hold or sell equity of investment or to access the stewardship or accountability of management. Creditors and suppliers use information to assess aegis for the amount lent to the enterprise.However, not all users of information surrender interest or confidence in the information provided by the management. Due to separation of ownership and control and managements ability of exploiting outsiders for their own benefits, legion(predicate) investors have no in terest or confidence in analyzing a companys fiscal rehearsals. Instead, they cuss on foodstuff analysis by other specialists about the psychology of the market and its effect on share prices.This report is focused on the diachronic be accountancy adopted by most of the countries and why, redden though has many conundrums associated with it, have governments accepted this system even with approachability of alternative accounting systems. This report details the benefits and criticism of historical bell accounting along with alternatives to historical make up accounting and their criticisms. 2. historic Cost AccountingThe historical be accounting determine an asset for relief public opinion poll conclusions at the price paid for the asset at the era of its acquisition.The historical represent accounting is the situation in which accountants record revenue, white plague and asset acquisition and disposal at historical woo that is, the veritable(a) amounts of money, or moneys worth, received or paid to complete the transaction. diachronic comprise is based on actual transaction earlier than forecasts. in that respect are supporting records for all the figures provided in the financial statements. It is also relevant in making economic decisions, as past data transactions are needed for making future decisions. Another defense of historical cost is that historical cost has been used throughout history as financial statements which use historical cost are found to be useful. returns is the excess of selling price over historical cost. Profit is a very well accepted concept of measure of performance. It is the difference betwixt revenue and cost that determines on decision to continue a harvesting line or division. diachronic Cost Accounting is very much based on this concept of profit and loss.Others, in defense of Historical Cost Accounting argue that historical cost is less defeat to manipulation of data than other forms of acco unting such(prenominal) as period Cost. The use of menstruation cost or qualifying price opens the verge to manipulation of these numbers. In other words, how are original costs to be determined and how can accountants determine which value is true and pleasure ground? much(prenominal) importantly accountants moldiness guard the integrity of their data against internal modification.Criticisms of Historical Cost AccountingOvertime, criticisms of historical cost accounting have been raised(a) by number of notable scholars, particularly in relation to its softness to provide useful information in clock of rising prices.3Historical Cost Accounting record all assets at an original cost and continue to use these historic figures throughout the assets life, while time-value of money is entirely ignored.Across time these criticisms appear to have been accepted to a sure degree by accounting regulators. In recent years various accounting standards have been released that requi re the application of fair values when measuring assets. For example AASB 116 gives financial statement preparers a choice between the cost model and the fair value model in measurement of property, plant, and equipment. pecuniary Instruments (AASB 139), investment properties (AASB 114), and biological assets (AASB141) are required to be valued at fair value as opposed to historical cost.chamber in 1966 argued that the historical cost accounting information suffers from problems of irrelevance in times of rising prices. It is also questioned whether it is useful to be informed about something that cost a particular amount many years ago whereas its reliable value might be considerably different. It has been argued that there is a real(a) problem of additivity.4The matter at issue is whether it is logical to added together assets acquired at different periods when those assets were acquired with amounts of different purchasing power.Alternatives to Historical Cost Accounting real Cost Accounting actual Cost Accounting (CCA) attempts to provide more realistic book values by valuing assets at received market buying prices. It takes into account time-value of money and inflation. It is more complex than the conventional accounting, and it has created argumentation about what adjustments are appropriate.Un alike(p) Historical Cost Accounting, there is no need for inventory cost flow assumptions such as last-in-first-out and plodding average. The business profit in CCA shows how the entity has gained in financial terms the change magnitude in cost of its resources, which is ignored by historical cost accounting. Differentiating affiance profit from property gains and losses has claimed to enhance the improvement of information universe provided by CCA. Holding gains are different from trading income as they are due to market-wide movements which are beyond the control of the management.5 on that pointfore, CCA doesnt rewards managers for profits from ho lding gains and losses which isnt an actual profit and also gives useful information to investors.Supporters of CCA are convinced that it provides more useful information than conventional accounting exclusively however they do not agree on all issues. There is one group who hope in the financial keen concept in which the holding gains is included in the profit and the other group is those who consider in the physical capital concept. Under physical capital concept, holding gains and losses are not included in the profit and are supported by the theory of optimal resource usage that uses current costs as a measure of input opportunity cost.Criticisms of Current Cost AccountingMeasurement errors may have degraded the usefulness of current-cost and replacement-cost data. Replacement-cost valuations of plant and equipment often include the cost of technological advances and often these advances would reduce operating costs below the level reported by historical cost. As a result, when replacement-cost depreciation is substituted for historical-cost depreciation, the cost of doing business includes the spunky capital cost of the advanced technology as well as the high operating costs of the older technology in use, which creates measurement errors.6The supporters of Historical Cost Accounting criticize CCA because it violates the traditional revenue recognition pattern by recognizing increases in the value of the assets, two current and non-current, before they are sold. This is irrelevant as changes in market price dont mean anything until the assets are sold. A non-current asset isnt more valuable to a business just because its current cost has increased.Another problem is the subjectivity of determining the amount of the increase in cost. There are some non-current assets that dont have a second-hand market because it was specifically built or made for that business only. So the basis of determining the current cost must be the newly asset expected to replace the old one.CCA also involves a numerical problem of additivity. This is because the figures generated from CCA arent of the same nature because it involves a variety of measurement models. drop dead Price AccountingExit Price Accounting (EPA) also cognize as Continuously Contemporary Accounting ( chocolate) has been proposed by researchers such as McNeal, Sterling, and especially Raymond chamber. Its an accounting theory that prescribes that assets should be valued at exit prices and that financial statements should function to inform about an organizations capacity to adapt.7Chambers depict the entitys capacity to adapt as the change that could be obtained if the entity sold its assets. Chambers believed that economic survival of the entity depends on the amount of cash it can eclipse and the balance sheet is crucial to these decisions.Chambers used the term current cash equivalents to refer to the amount that was expected to be generated through the natty sale of as sets. He believe that the information about current cash equivalent were fundamental to effective decision making.Chambers stated that the accounting rules used were so different in effect that comparison between companies was often quite misleading.8One of the main(prenominal) arguments for EPA is that it provides useful information to the users. They believe that EPA reports all profits and losses and values as determined in competitive markets and provides a true and fair financial statement that serves the purpose of the shareholders.Other arguments that support EPA is the additivity function. EPA values all elements in the balance sheet and income statement at their exit prices, which, therefore, provides one consistent rule that could be applied by all or any company. It involves references to real-world examples because untestable assertions arent made such as depreciation.Criticism of Exit Price AccountingAccording to Chambers model of CoCoA, if assets cant be sold separate ly, they are deemed to have abruptly no value for the purpose of determining organizations financial position. This is considered to be in like manner extreme by many accounting practitioners and researchers. Assets such as thanksgiving and work-in-progress have no selling value therefore will be have no value at all in the financial statements.Other criticisms of CoCoA are that it doesnt consider the value in use. An asset that is held rather than sold out must be worth more to its owner than its exit price, otherwise, it would be sold. In case of specialized resources such as a blast furnace has compulsive value in use, but cannot be sold separately, for the purpose of CoCoA has no value.9Even though proponents of EPA argue for the additivity of exit prices, the concept of current cash equivalent doesnt cognize the possibility of selling assets as one package. Some assets sold as a package are worth more than when sold distributively in the market. This concept has been igno red in the exit price accounting.CoCoA has also been criticized on the basis that exit prices are determined by the price that could be achieved in an orderly sale.10The sales might be at different times and wont necessarily reflect values at balance date. Therefore, the financial statements based on these values might not be useful for monitoring the companys management.Positive Accounting system and Efficient Markets speculationMilton Friedman was the one who strongly supported and backed the positive(p) theories in economics. He stated that the ultimate goal of a positive science is the development of a theory or hypothesis that yields valid and meaningful predictions about phenomena not yet observed. Watts and Zimmerman also stated that the objective lens of positive accounting theory is to explain and predict accounting utilization which was consistent with the views of Friedman.The beginning of positive accounting theory is the Efficient Markets Hypothesis (EMH). The EMH is based on the assumption that capital markets react in an effective and unbiased manner to publicly available information. The main strengths of Positive Accounting Theories over Normative Accounting Theories are the facts that hypothesis are frame in such a way that they are capable of refutation by experimental research. Also, these theories aim to provide an understanding of how the world works rather than stating how the world should work. Moreover, PAT tries to understand the relationship and connection between various accounting information, managers, firms, and markets and also analyze these relationships within an economic framework.There are several assumptions made in development of positive accounting theory. The first is that the firm is a nexus of contracts. In relation to PAT, because there is a need to be efficient, the firm will want to lessen costs associated with contracts. Contract costs involve accounting variables as contracts can be stipulated in terms of accounting information such as net income, and financial ratios.11The firm will choose the accounting policies that outdo acknowledge the need for minimization of contract costs. PAT recognizes that changing draw require managers to have flexibility in choosing accounting policies which brings forward the problem of opportunistic behavior. This occurs when the actions of management are to better their own personal interests.The other assumption is that the managers are rational economic decision makers and will act to maximize their own profit and not the profit of the company. Under PAT, firms want to maximize their prospects for survival, so they organize themselves efficiently.Criticisms of Positive Accounting TheoriesOne of the main criticisms of PAT is that it doesnt provide prescription for accounting and therefore doesnt provide any means of improving accounting practice.12This, therefore results in alienation of practicing accountants. It is argued that only when explain and predicting accounting practice is not enough. There is no centering on what people should do, as there is a general absence seizure of prescription.The other criticisms of PAT relate to the fundamental that all action is impelled by a desire to maximize wealth. Many researchers find this statement very negative in nature. They believe that PAT promotes a virtuously bankrupt view of the world. The concept of positive theory is drawn from an obsolescent philosophy of science and is in any case a misnomer, because the theories of empirical science make no positive statement of what is.13And also of course, Watts and Zimmerman do say, We do not contend that all issues are settled, but rather encourage others to pursue, correct, and extend our analysis.ConclusionQuite clearly the several limitations and flaws of the traditional historical costs method have been highlighted and picked upon from time to time. Still historical costs are the standard form of accounting due to its unc ommon features and conventions that make it better than most available alternatives. Historical cost accounting has and is still been widely recognized and accepted by corporations across the world.There hasnt been any development of better alternatives to Historical Cost Accounting. The alternative accounting such as current cost accounting and exit price accounting carry more problems in them than historical cost accounting. For examples countries like Unites States and United Kingdom have tried to adopt current cost accounting system but later withdrew as there were many complexities in using current cost accounting. Even if accounting bodies only when pick an existing method to form the standard of accounting, it will decidedly not be better than historical cost accounting.However, in my opinion, the current use of historical cost accounting by many firms have been a contributing factor in masking the true and fair value of their assets. As investors are the primary users of f inancial statements, priority must be given to the needs and wants of the shareholders. Empirical evidences show that investors want both measurements i.e. historical cost and current cost accounting.14I believe a process should be created where historical cost and current cost operate side-by-side, which will enhance relevance, reliability, and comparability. Rather than debating between different approaches, focus should be given to implement an accounting system which reports all assets and liabilities at their true value without eliminating the benefits of historical cost accounting.