Analyzing the Conceptual Framework of Historical Cost Accounting

This study analyzes the conceptual framework of historical cost accounting, including its strengths, weaknesses, and comparison with current cost accounting methods.

Running head: ANALYZING THE CONCEPTUAL FRAMEWORK OF HISTORICAL COST
ACCOUNTING
Analyzing the Conceptual Framework of Historical Cost Accounting:
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ANALYZING THE CONCEPTUAL FRAMEWORK OF HISTORICAL COST
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Introduction
` The IASB conceptual framework has stated standards and rule regarding the costing of
assets and items. Historical Cost Accounting is the most used method of Cost accounting used by
the accountants, but a criticism on the method is raised. The study below discusses about the
historical cost accounting and analyses the process of measurement, the weaknesses and strengths
of the model. The historical cost accounting is analyzed by identifying various issues mentioned
through criticism in various arguments. In the study below, the issues related to the irrelevance of
information, under the Historical Cost accounting is analyzed and the significance of the model is
also considered. The Historical Cost model is also analyzed by comparing it with various methods
of Current accounting model. The three methods of current cost accounting model, CPP, CCA,
COCOA, are analyzed by identifying the measurement process, and the strengths and weaknesses
from the criticism against the Cost Accounting Model. Through the comparison of the criticism of
the historical cost accounting and the current cost accounting model with specific evidence, it will
be concluded that the historical cost model is more suitable than the current cost model. In the
study various arguments on the conceptual framework been used as a device to ensure the existence
of ongoing business is been analyzed and disagreed with proper justification. The role of the IASB
conceptual framework in issue of measurement is also been stated as the accounting standard have
been shifted from the use of historic accounting to the fair value. The fair value accounting is more
suitable than the historic accounting s been concluded at the end of the study in the conclusion.
Discussions
Historical Cost Accounting refers to the concept where the value used in accounting are
measured, in which the price of an asset taken in the balance sheet is either its original cost or based
on its nominal accounting. In the historical cost accounting method, the historical values of the
assets are taken into account i.e. that value of the assets when it is acquired. The historical value
does not consider the concept of time value of money. The method presents the true value of the
assets in the financial statement, but hence the value of the asset does not consider the time value
concept, hence fails to present the actual financial position of the company. Under the generally
accepted accounting principles (GAAP), the principle accounts of historical cost for the assets, in
the balance sheet of a company based on the capital amount that is spent to purchase it. There is
many objections raised related to this method, where some of them were arguing in favor of the
method, while some of the arguments are against the method.
There are a number of arguments supporting this method, and one of the argument is that, as
stated in paragraph 4.55 (a) of the IASB ‘Conceptual Framework for Financial Reporting’, the

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assets are recorded at the value of the amount paid in cash or cash equivalent, or at the fair value of
that of the consideration in order to acquire the during the their acquisition and the liabilities are to
be recorded at the value of the amount of the proceeds received on the exchange of the obligation
or at the amount that are expected to be paid to meet the liability in the normal period or course of
the business. This argument supports the concept in a ways that it helps to capitalize the assets to
pay its debt. For example in some cases such as income taxes, the liabilities are recorded at the
amount expected to be paid to pay and meet the liability in the normal course of time. There is
another argument that supports the concept of historical cost accounting, where The AASB states
that the historical cost accounting is more reliable than the current cost accounting, because it
provides the actual cost data, which is during the time of acquisition. Due to the fact that the
investors or the auditors will prefer historical accounting more, because it is more reliable as the
method considers the actual cost of the item and hence the chance of data misinterpretation is very
low.
However, there are also many criticisms released regarding the historical cost accounting
and its concept of recording historical data. One of the arguments, supporting the criticism of the
historical cost accounting concept states the limitation of historical cost accounting during the time
of rising prices. In the argument, it is argued, that the information from the historical cost
accounting process faced issues of irrelevance of information in times of rising prices (Chambers,
1966). The argument questions that whether it’s fair or useful to consider something, cost of which
is many years ago, but the current value is different. The other issue identified in the same
argument is the issue of additivity, which means that adding of two assets that is acquired at two
different periods with currency with different purchasing power, is not logical. There is another
argument, supporting the criticism and adding points. Elliot (1986) states that the most troublesome
assumption in the model of historical cost accounting is that the monetary unit used during the
transaction remains fixed and constant, where there are three components of modern economy that
makes the assumptions less valid. These components includes specific price-level changes which is
occasioned by things such as shift in consumer preferences or technological advances; general
price-level changes, also known as inflation; and fluctuations in actual rate of currencies, as a result
of which the book value of a company only shows the current value of assets in the financial
statement. For example, inventory not necessarily is measured at cost like current accounting
model, and plant, property and equipment cannot be valued at cost, where the business has adopted
the historical accounting method. The above criticisms are partially justified, because the present
value of the currency or the purchasing power won’t make the huge difference as, it will be
contrasted with the future value of the asset.

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In the field of accounting, there are also Current accounting methods, where the current
values of the assets are taken into account, unlike the historical cost accounting. There are mainly
three methods of current accounting, Current Purchasing Power (CPP), Current Cost Accounting
(CCA) and Continuously Contemporary Accounting (COCOA). The CPP is the most common and
also the most popular method of current cost accounting.
The current purchasing power method is referred by many researchers and addressed as the
revolutionary model of costing. CPP is an accounting measurement that shows the effect of the
increase in monetary value i.e. the inflation on the value of money unlike Historical cost
Accounting, by converting the historical costs of the items into current prices by using an approved
and specific index such as consumer price index (CPI). In CPP method of accounting, a
supplementary statement is prepared which includes re-statement of income statement and also re-
statement of balance sheet. The net gain or loss account of monetary items is accounted in the profit
and loss account in CPP method. Under the CPP method, financial statements are prepared by
considering the historical cost, by preparing a supplementary statement that will show the historical
items in the current value of the company. The price index calculated is referred to as the base
period.
Continuously contemporary Accounting (COCOA) is another efficient current cost
accounting model, where the model states the concepts that the purchasing power of money is not
constant, however it is continuously changing and very current. According to this model, the
monetary worth or value of the firm, that is realised, is equal to the value of the firm’s cash and
cash equivalent. This accounting system measures the assets and liabilities of the firm at their
current cash price, rather than the historical prices, for example, sale of an asset at its net realisable
value in the current business condition. It is a requirement for the system for the business to adopt
the recent and most evolving ecosystem, in which their operations and accounting practices forms.
The adaption process under this method implies acquisition of most suitable assets for the business
in its new environment and by disposing the unsuitable assets that deemed unfit for the business.
Continuously Contemporary Accounting (COCOA) model demands the business to include
the current predictive selling prices of the assets particularly and hence the net revenue of the
company could be calculated as the change in the adaptive capital of the firm during that period.
The main advantage of the model is it is very easy to follow by the accountants of the business in
preparation of the financial statement, and since the model constantly suggests the business to buy
and sell the firm’s assets, hence help the business to survive in competitive environment. There are
also some major limitations in applying the model, where the main weakness of the accounting

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model is that the model demands a fundamental shift, from a cost based, by exiting from the price
system.
Current Cost Accounting (CCA) is the other model of Current Accounting system, and this
method is used as an alternative of the Current purchasing power method. Current Cost Accounting
(CCA) is an approach that recognizes the changes in the price, which is affected because of the
change in the general price level. Unlike the COCOA model, this method applies the process of
preparing and presenting financial statement, where the relevant changes in the price is to be
considered to be significant. In this method the valuation of the assets are in current cost basis and
the retail price index is not considered, but considers the alteration value of the assets for the
purpose of its real accounting records in its balance sheet. The revaluation surpluses are not
distributed to its shareholders as dividend, but are transferred to the current cost accounting reserve,
under this CCA model. The primary objective of the model is to provide the actual and reliable
financial information in the financial statement of the company based on the current replacement
cost. This model can be a replacement of the historical cost, because it considers the current value
and still aims to provide the most reliable information.
The Advocates of the Current Accounting methods argues and takes stand on various points
and advantages as discussed above. The main advantage of the current cost accounting, on the basis
of which the advocates argues is the consideration of present value of the assets in reporting the
financial statement of the company, because it provides more fair book value of the company’s
financial position. All the three methods follows different process of calculating the present value
and implementing it as discussed above, but still manage to fulfil its key objective. Analysing the
similarities of all the Current Accounting methods, CPP, CCA and COCOA, all of them uses the
same ways of allocation of assets after revaluation.
However, there are many researchers who are arguing against the implementation of these
models claiming that these models have some serious disadvantages. On the basis of the
disadvantages as discussed above, such as the weakness of the COCOA, where it demands the
fundamental shift, which affects the current financial position of the company and of the
company’s accounting environment. The main disadvantage of CCA is regarding the accuracy of
the information provided by the model, as the cost determined under the model is not certain, thus
there is a risk due to the uncertainty and thus to verify it, reconciliation of the statement is required.
The Historical cost accounting and the Current cost accounting, both measures the values or
cost of the assets or securities, which are to be reported or recorded in the balance sheet, in
financial statement of the business. Both of the model have same primary objective, but still have

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different ways of execution, where the historical cost considers the original cost of the assets from
its historic value when the asset is acquired, while the current cost method considers the current
value of the assets which is calculated by periodically and constantly updating the value of the
items, and then the revalue amount is reported in the balance sheet of the company. Except from
the effect of the rising prices in the Historical cost method, historical cost method is the best
method for measuring assets and items of the business. By applying the relevant characteristics and
features of both the models, it can be concluded that the Historical cost accounting method is the
most preferable model in measuring the assets in the financial statement.
The Conceptual framework of accounting can be defined as the system that is consists of
ideas and objectives and ideas, which finally creates a set of rules and standards, which is followed
consistently, during accounting. The standards of the conceptual framework helps in setting the
nature, limits and functions of the financial accounting. The IASB conceptual framework help
developing the future IFRS and providing review in existing IFRS.
Conclusion
The above study concludes that the IASB conceptual frame work is supporting the historic
cost model for the purpose of assets valuation and fair value. The study also concludes that the
historic cost accounting provides more accurate and fair value of the asset than the current cost
accounting model and hence the most suitable model for assets valuation. The study at the end also
concludes that the replacement of historic accounting with fair value is justified and hence the fair
value model of accounting is more suitable.

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