Historical Cost Accounting Criticisms and Current Cost Advocacy

1. Prepared by Arabella Volkov University of Southern Queensland

2. Criticisms of Historical Cost Accounting • Objective of accounting • Does the model fulfill the stewardship role? • Information for decision making • The model may lack relevance for decision making • Basis of historical cost • Going concern assumption

3. Criticisms of Historical Cost Accounting • Matching of revenues to expenses • Notions of investor needs • Distortion of or concealment of important company disclosures • Historical cost under attack • Increasing use of other valuation models

4. Summary • Advantages and disadvantagesof the historical cost system • The objective of accounting • Relevance v. reliability

5. Key Terms and Concepts • Historical cost model • Costs attach theory • Historical cost valuation • Alternative models • Historical cost accounting

6. Where to get more information • Other courses • Accounting handbook • List books • Articles • Electronic sources

7. Criticisms of Current Cost Advocates of historical cost • CCA violates realisation principle • Subjectivity of increase Advocates of exit price • Cost implies opportunity cost • Allocation problem (Thomas) • Current operating profits could be poor predictors of future profits (Lemke) • Additivity problem (Chambers)

8. In support of Current Cost • Recognition principle • Holding gains should be recognised if there is objective evidence of a price change • Objectivity of current cost • Depends upon visibility of market price item

9. In support of Current Cost • Technological changes • Is profitability expected to be higher with new technology? • Current cost v. exit price • Current cost is the normal valuation method

10. In support of Current Cost Comparison of the results with historical cost

11. In support of Current Cost Empirical studies • Australia • United States • New Zealand • United Kingdom • Research related to the IFRS

12. Empirical Evidence • Capital markets research • Supplementary current cost data not useful • Not value relevant for stock prices • Financial capital not used for valuation • Watts & Zimmerman alternative interpretations of results • Financial asset current costs appear to have more value relevance

13. Summary • Proponents of CCA believe it provides more useful information. • Financial capital concept • Physical capital concept • This view is not supported by empirical studies. • Watts and Zimmerman offer four alternative interpretations • Companies argue the cost of providing CCA information outweighs any benefit.

14. Key Terms and Concepts • Current cost • Holding gains and losses • Business profit • Physical capital • Recognition principle

15. Where to get more information • Other courses • List books • Articles • Electronic sources