Historical Cost
Lectured by Dr. Siriluck Sutthachai
Accounting Department
Faculty of Management Science
Khon Kaen University
Khon Kaen, Thailand
Historical Cost

The amount actually paid for an item is more
concrete and objective than an amount that one
would have paid.

Acquisition cost represents more of a reality to a
particular firm than market price.

The financial statements represent the result of
past performance.
Defence of Historical Cost
Relevant in making economic decision.
 Based on actual, not merely possible,
transactions.
 Throughout history; financial statements based
on historical cost have been found to be useful.
 The best understood concept of profit is the
excess of selling price over historical cost.
 Accountants must guard the integrity of their
data against internal modification.

Defence of Historical Cost

How useful is income information based on
current cost or exist price?

Changes in market prices can be disclosed as
supplementary data.

There is insufficient evidence to justify rejection
of historical cost accounting.
Criticism of historical cost
Objective of accounting and Information for
decision making.
 Basis of historical cost—the ‘going concern’
assumption.
 Matching—fraught with estimates and
assumptions such that its application can be
described only as arbitrary.
 Notions of investor needs—the distortion or
concealment of company disclosures.

Current-Value Accounting
Current-Value Accounting

For accounting information to be decision
useful, it must measure the actual events of a
particular period as accurately as possible.

Under the current cost accounting concept,
accounting information serves two purposes:
 The
evaluation by managers of their past decisions
in order to make the best possible decisions for the
future.
 The
evaluation of managers by shareholders,
creditors and others.
Current-Value Accounting
Concepts of business profit:

Current operating profit: the excess of the
current value of the output sold over the current
cost of the related input.

Realisable cost savings: the increase in the
current cost of the assets held by the firm in the
current period (holding gains/losses).
Current-Value Accounting
Current value can be calculated on the basis of:

Capitalization, or the present-value method;

Current entry price;

Current exist price; or

Combination of values derived from these three
methods.
Current-Value Accounting
Capitalization, or the present-value method
 The net amount of the discounted expected cash
flows pertaining to the asset, group of assets, or total
assets during their useful lives.
Four variables must be known:

The expected cash flows

The timing of those expected cash flows

The number of years of the asset’s remaining life

The appropriate discount rate
Current-Value Accounting

The capitalized-value method is deemed useful
for such long-term operating decisions as
capital budgeting and product development.

The capitalized values of long-term
receivables and long-term payables are also
used in financial statements.
Current-Value Accounting
Limitations:

The subjective nature of the expectations used for its
computation

The lack of adequate adjustment for the risk preferences of all
users

The ignorance of the contribution of factirs other than physical
assets to the cash flows

The difficulty of allocating total cash flows to separate factors
that comprised the contribution

The fact that the marginal present values of physical assets used
jointly in operations cannot be added together to obtain the
value of the firm.
Current-Value Accounting
Current Entry Price
 The amount of cash or other consideration that would
be required to obtain the same asset or its equivalent.

Replacement cost-used: the amount of cash or other
consideration that would be needed to obtain an equivalent
asset on the second-hand market having the same
remaining useful life.

Reproduction cost: the amount of cash or other
consideration that would be needed to obtain an identical
asset to the existing asset.
Current-Value Accounting
Current Entry Price

The valuation of assets and liabilities at current entry
prices gives rise to holding gains and losses

The realized holding gains and losses that correspond to the
items sold or to the liabilities discharged;

The non-realized holding gains and losses that correspond to
the items still held or to the liabilities owed at the end of the
reporting period.
Current-Value Accounting
Current Entry Price
 The holding gains and losses may be classified
as:
 Income
when capital maintanance is viewed solely
in money terms.
 Capital
adjustments, bacause they measure the
additional elements of income that must be
retained to maintain the existing productive
capacity.
Current-Value Accounting
Current Entry Price
 The advantages of the separation of current operating
profit and holding gains (or losses):

Useful in evaluating the past performance of managers.

Useful in making business decisions.

Current operating profit corresponds to the income that
contribute to the maintainance of physical productive
capacity.

Provide important information that can be used to analyze
and compare interperiod and intercompany performance
gains.
Current-Value Accounting
Criticisms of current-entry price

The price is based on an asuumption that
current-entry-price data is easily obtained.

Recognising current value as a basis of
valuation but does not account for changes in
the general price level.

What is meant by ‘current entry price’? Is an
asset held for use or sale to be replaced by an
equivalent, identical, or new asset?
Current-Value Accounting
Current Exit Price
 The amount of cash for which an asset might
be sold or a liability might be refinanced.

The price is generally agreed to correspond to:
 To
the selling price under conditions of orderly
rather than forced liquidation; and
 To
the selling price at the time of measurement.
Current-Value Accounting
Current Exit Price

All assets and liabilities are revalued at their
net realizable values

Net realizable values are generally obtained
from market quotations adjusted for estimated
selling costs and therefore correspond to the
quoted sales prices on the demand market.
Current-Value Accounting
Whenever net realizable values cannot be
estimated directly from the demand market,
two alternatives may be considered:

The use of specific sales price indices,
computed either by external sources or
internally by the firm; and

The use of appraisals by external appraisers or
by management.
Current-Value Accounting
Advantages of current exit price:

Measures of the economic concept of opportunity costs.

Provides relevant and necessary information on which
to evaluate the financial adaptability and liquidity of the
firm.

Provides a better guide for the evaluation of managers
in their stewardship function.

Eliminate the need for arbitrary cost allocation on the
basis of the estimated useful life of the asset.
Current-Value Accounting
Disadvantages of current exit price:

Relevant only for assets that are expected to be sold for
a determined market price.

Not relevant for assets that the firm expects to use.

The valuation of certain assets and liabilities at the
current exit price has not yet been adequately resolved.

Abandonment of the realization principle at the point of
sale.

Does not take into account changes in the general price
level.