AFAR2 QU QIU HONG

Table of contents

Question 1

2
1. Introduction
2
2. Criticisms of Historical Cost Accounting
2
3. Benefits of Historical Cost Accounting
3
4. Conclusion
3

Question 2

4

References

6

Question 1

1. Introduction

The Framework of International Accounting Standards Board (IASB) defines historical cost as “A measurement basis according to which the transactions are recorded base on the original cost.”

Usually five bases of measurement are used in financial reporting (1) Historical cost, (2) Current cost, (3) Fair value, (4) Realisable value, and (5) Value in use. Historical cost is the most commonly used basis of measurement from these bases. For example, 10 units of raw item were purchases one month back for RM 10 per unit. However, the market price today is RM 9 per unit. The inventory shall appear on balance sheet at its historical cost of RM 100 rather than RM 90 (Obaidullah, 2014).

2. Criticisms of Historical Cost Accounting

Overtime, criticisms of historical cost accounting have been raised by number of notable scholars, particularly in relation to its inability to provide useful information during the time of inflation.

One criticism is that historical cost accounting would overstate the profit during inflation period. Ray (2006) argued that Income statement prepared under historical cost accounting does not reveal the true profit because the revenues are recorded on current value basis whereas expenses are recorded at historical cost.

Baxter in 2003 on the other hand criticized that historical cost accounting fails to present a fair value of financial position. Balance sheet consists of monetary and non-monetary items. Monetary items like cash, loan, debtors, creditors etc. are shown at their current money value. Non-monetary items like inventory, building, land etc. are shown at historical costing, not at current value. During period of inflation, non-monetary items are understated. Thus, balance sheet fails to present a fair value financial

References: Bakar, N. B., & Said, J. M. (2012). Historical Cost versus Current Cost Accounting. Business & Accounting, P121. Baxter, W. (2003). The Case for Deprival Value. Scotland: Institute of Chartered Accountants of Scotland. Bocij, P. (2009). Business information system. London: Financial times pitman publishing. Christensen, J., & Demsi, J. (2005, Feb 2). The non-neutrality of reporting standards. Retrieved from http://bear.cba.ufl.edu/demski. Edwards, & Philip. (2004). The theory and measurement of buisness income. California: University of California Press. Graham, L. (2012). Accountant 's handbook. US: Carmichael. Jan, O. (2012, feb 4). Substance over form. Retrieved from Accoutning Explanied: http://accountingexplained.com/financial/principles/substance-over-form Jennings, M Obaidullah, J. (2014, Jan 3). Historical cost concept. Retrieved from Accounting explained.com: http://accountingexplained.com/financial/principles/historical-cost Peter, H., & Elizabeth, B Ray, B. (2006). Pros and cons for investors. In R. Ball, International Accounting Policy Forum, special issue of Accounting and Business Research (pp. p172-174). Forthcoming. Robert, R. S. (2007). Theory of the measurement of enterprise income. Kansas: Univeristy of Kansas Press. Shafir, E. (2008). The impact of irreversibility, unvertainty and timing options on deprival valuations and the dectection of monopoly profits. London: HMSO.