Benefits and Problems of Historical Cost Information in Accounting

1
ACC518 - Current Developments in Accounting Thought

2
Introduction
The present report is being developed for analyzing the benefits of the historical cost
information and analyzing its problems. It is followed by providing a discussion of alternative
method of accounting developed for historical method of accounting. It is then followed by
analyzing the benefits of conceptual framework for improving the legitimacy of financial
reporting. Lastly, it has discussed the benefits of fair value as compared to historical method of
accounting and need for developing better method of accounting by conceptual framework as
compared with fair value method.
Answer 1: Analysis of statement ‘Historical Cost Information suffers from problems of
relevance in terms of rising prices’ and evaluation of the other methods that are
alternatives to historical cost information
The method of historical costing can be regarded as an accounting method that
recognized the value of an asset on the financial statements of a company based on the original
price at the time of its purchase. The historical cost of an asset can be regarded as the capital
incurred by a company at the time of its purchase. The method has been largely used by the
accountants for recognizing the value of an asset on the balance sheet as it is relatively easy and
reliable method of calculating the cost of an asset on the basis of its past transactions. However,
it has been regarded by the various accounting researchers such as Chambers (1996) that
accounting information provided by the historical costing method lack relevance at the times of
rising prices. This is largely because the method records the cost of an asset based on its value
many years ago and as such its vale might be considerably different from its present market
value. The method does not take into consideration the changes in the value of an asset due to the
market changes such as increase in the prices and therefore fail to depict the actual financial
position of an organization. This could lead to understatement of the price of an asset and
therefore the net book value of an entity might fail to represent the actual worth of an entity
(Schmidt, 2014).
The depreciation and the cost of goods sold are stated on the basis of historical cost of an
asset leading to overstatement of profits in terms of rising prices. This could results in paying the
dividends from the profits that could negatively impact the operational efficiency of an entity by
allocating large amount of returns to the shareholders and less has been retained for carrying out
its operational activities. In addition to this, this method of accounting can results in distorting
the financial results of a company reported for a current period in times of increasing prices. For
example, as asset such as machinery is acquired for $10,000 and its value increases by $1000 on
an annual basis in times of rising prices. As such, if there has been no revaluation undertaken
annually on the value of an asset and if it has been sold in the 5th years for $15,000 then a gain of
$5,000 realized would only be depicted in the current financial period. Therefore, the gains
realized will not be reported in the financial period of any other year resulting in distortion of the
financial information. The method of accounting seems to be inappropriate in determining the

3
amount of money that was lost significantly on a particular asset due to inflation (Tinkelman,
2017).
The lack of reliability of historical costing information in times of increase in the price
level has caused the accountant and investors to adopt the use of other approaches for achieving
accurate financial results. The fair value method of accounting has larger been emphasized by
the accounting researchers to be used for providing information about the financial assets and
liabilities of a business entity. It is also known as mark-to-market method of accounting that
records the value of an asset on the basis of the current market price on the balance sheet. The
major advantage of fair value accounting over historic method of accounting as it provides
accurate values of an asset and liability as per the current market situations (Deegan, 2014). The
values of an asset or liability are changed by the company as per the increase or decrease in their
value. Thus, business entities developing their financial statements as per the use of fair value
accounting method are able to improve the accuracy of their financial information. The reflection
of assets and liabilities value as per the current market situations proves to be largely useful for
investors to gain realistic financial information of a company. As such, the method of accounting
enables investors to make accurate investment decision by examining the actual net worth of a
company. The improvement in the consistency in reporting of financial assets and liabilities
value will improve the comparability of financial information (Deegan, 2014). As such, it can be
said that this method of accounting has significant advantage over the historic method of
accounting in providing reliable and accurate financial information to the stakeholders of a
company (Zyla, 2009).
Answer 2: Analysis of Statement ‘Conceptual frameworks have been developed to 'boost'
the public standing of the profession or not’
The conceptual framework of accounting has been developed by the IASB (International
Accounting Standard Board) as a means of regulating and monitoring the financial reporting
process of organizations across the world. The conceptual framework of accounting can be
described as a system of ideas and objectives that lead to the creation of consistent set of
accounting rules and standards guiding the financial reporting processes. The main objective of
developing the conceptual accounting framework is to improve the quality of financial reporting
process for protecting the interests of an entity various stakeholders. It has been stated by various
accounting researchers that conceptual framework is often developed as a means for increasing
stewardship in financial reporting process. This implies that financial reporting process of a
business corporation should be responsible towards its end-users such as investors and creditors
and promotes their welfare (Taylor and Francis, 2009).
However, it has been stated by various accounting researchers such as Deegan (2014) that
standard-setting bodies such as IASB have developed conceptual framework of accounting
merely for the purpose of realizing their own benefits. It has been argued by the accounting
researchers that it is used as a device for boosting the public standing of the accounting standard-