Steven Orlando

LB53 / 2101680546
GSLC 2
PAGE 206

1. According to the historical cost system, what is objective of accounting and the role of
profit? What criticisms are made of profit calculated under the historical cost systems?
According to the historical cost system :
 The objective of accounting : Seen as monitoring the stewardship function of
management by calculating income and valuing net assets in a conservation way.
 The role of profit : The accounting entity must first retain the same
amount of capital that it had at the beginning of the same period where all assets
and liabilities are valued at their historical purchase cost.
The criticisms that are made of profit calculated under the historical cost system is income
with no recognition of the changing value of assets and liabilities is misleading and
results in incorrect dividend policies. This is because there maybe losses or gains simply
from holding assets and this should be recognized when evaluating performance on
regular basis.

2. Explain the concept of “costs attach”. What do critics say about the concept? What is
meant by the terms “unexpired cost” and “expired cost”?
Cost attach theory is a theory based on assumption that the value of any commodity,
service or condition used in production passes to the object or product for which the
original item was expended and attaches to the result, giving it value. There are two
components of the theory :
 Displacement cost, which denotes what has been given up and is synonymous
with opportunity cost
 Embodied cost, which relates to the factors of production and what has been
outlaid rather than forgone.

Paton and Littleton admit that in the typical situation one cannot find a basis for ‘cost
attach’. In effect, accountant do not directly associate costs with revenue, but match costs
to intervals of time. an assumption is made that costs assigned to a given period as
expenses must therefore have helped to generate the revenue for that period.

Unexpired cost is any cost that has not yet been charged to expense because it still
represents some residual value. This cost is frequently associated with revenue that has
not yet been recognized.
Expired cost is a cost that has been recognized as an expense. This happens when an
entity fully consumes or receives benefit from a cost. An expired cost may also be
construed as the total loss in value of an asset. A cost for which a portion is still recorded
as an asset and a portion has been recognizes as an expense can be considered a partially
expired cost.
4. What are the three types of decision managers are faced with in running a business? How
does accounting enter the decision-making process?
Three types of decisions that are faced by management:
 Holding decisions about whether to ‘hold’ assets and liabilities or to dispose of
them (e.g. through sale of assets or repayment of debt).
 Operating decisions about how to use and finance the entity’s operations.
 Business profit decision about comprising current operating profit and realizable
cost savings.
Accounting does help management during decision making process. Cost accounting can
provide information the managers of a firm want to know how they should allocate the
firm’s resources in order to maximize profits. A useful tool is a comparison of accounting
data for a given period with expectations originally specified for that period. If this
comparison reveals that expectations were inaccurate, current events or expectation
should be altered. For accounting information to be useful in decision making, it must
measure the actual events of a period as accurately as possible.

6. What are the benefits of separating out the holding gains (or losses) in profit
determination? What are some shortcomings of this separation?
Capital is a real financial proprietorship concept which means that profit is determined
after restating opening buying values (capital) at the general price level, that is, profit is
the increase in business profit and holding gains and losses after adjusting for any
increases or decreases in the general price level.

The benefits of separating out the holding gains (or losses) in profit determination :
 Holding a certain composition of assets and liabilities is one way management
tries to enhance the firm’s market position.
 Under historical cost accounting, gains are recorded only when the assets are
disposed of. Therefore, determining whether management’s holding activities are
successful or not is virtually impossible unless assets are bought and sold in the
same period. The separation of holding gains and operating profit gives credit to
the appropriate managers.

Some accountant argue that a company purchases most assets to use in its operations,
regardless of price changes. Therefore, the possibility liquidation of assets is unrealistic.
This rationale is inappropriate for a current cost concept because its emphasis is on
liquidation value or exit price, whereas current cost accounting measures assets at entry
(cost) values. Investors are concerned about the future cash flows of the company,
especially in terms of dividends to themselves and proceeds from the sale of their shares.
In the long run, profits and dividends are directly related to using the operating assets, not
liquidating them.