Prepared by Arabella Volkov
University of Southern Queensland
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
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
Summary
• Advantages and disadvantages
of the historical cost system
• The objective of accounting
• Relevance v. reliability
Key Terms and
Concepts
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Historical cost model
Costs attach theory
Historical cost valuation
Alternative models
Historical cost accounting
Where to get more
information
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Other courses
Accounting handbook
List books
Articles
Electronic sources
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)
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
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
In support of Current Cost
Comparison of the results with
historical cost
In support of Current Cost
Empirical studies
• Australia
• United States
• New Zealand
• United Kingdom
• Research related to the IFRS
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
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.
Key Terms and Concepts
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Current cost
Holding gains and losses
Business profit
Physical capital
Recognition principle
Where to get more
information
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Other courses
List books
Articles
Electronic sources