6 Historical Cost

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 costthe going
concern assumption.
Matchingfraught with estimates and
assumptions such that its application can
be described only as arbitrary.
Notions of investor needsthe distortion
or concealment of company disclosures.
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.
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 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.
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 assets remaining life
The appropriate discount rate
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.
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 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 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 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 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.
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 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 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.
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.
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.
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.

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Historical Cost

Lectured by Dr. Siriluck Sutthachai

The amount actually paid for an item is

Acquisition cost represents more of a

The financial statements represent the

Defence of Historical Cost

Defence of Historical Cost

How useful is income information

Changes in market prices can be

There is insufficient evidence to justify

Criticism of historical cost

For accounting information to be decision

Under the current cost accounting concept,

evaluation by managers of their past

evaluation of managers by shareholders,

Current operating profit: the excess

Realisable cost savings: the increase

Capitalization, or the present-value method;

Current entry price;

Current exist price; or

Combination of values derived from these three

The expected cash flows

The timing of those expected cash flows

The number of years of the assets remaining life

The appropriate discount rate

The capitalized-value method is deemed useful

The capitalized values of long-term

The subjective nature of the expectations used for its

The lack of adequate adjustment for the risk preferences of all

The ignorance of the contribution of factirs other than physical

The difficulty of allocating total cash flows to separate factors

Replacement cost-used: the amount of cash or other

Reproduction cost: the amount of cash or other

The valuation of assets and liabilities at current entry

The realized holding gains and losses that correspond to the

The non-realized holding gains and losses that correspond to

when capital maintanance is viewed solely

adjustments, bacause they measure the

Useful in evaluating the past performance of managers.

Useful in making business decisions.

Current operating profit corresponds to the income that

Provide important information that can be used to analyze and

The price is based on an asuumption that

Recognising current value as a basis of

What is meant by current entry price? Is an

The price is generally agreed to correspond to:

selling price under conditions of orderly

selling price at the time of measurement.

All assets and liabilities are revalued at their

Net realizable values are generally obtained

The use of specific sales price indices,

The use of appraisals by external appraisers or

Measures of the economic concept of opportunity costs.

Provides relevant and necessary information on which

Provides a better guide for the evaluation of managers

Eliminate the need for arbitrary cost allocation on the

Relevant only for assets that are expected to be sold for

Not relevant for assets that the firm expects to use.

The valuation of certain assets and liabilities at the

Abandonment of the realization principle at the point of

Does not take into account changes in the general price

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