An analysis of balance sheets prepared using historical cost accou… Essay

Historical cost accounting values the assets and liabilities of a company at the monetary value paid or the liability agreed, at the clip of acquisition. These values are written down in the balance sheet at the terminal of each twelvemonth and they must be to the value the company has been financed. Although utilizing this method excludes accommodations for rising prices, the cost still needs several accommodations when ciphering the book value. The most of import of these are depreciation, depletion and damage. Most companies do non happen this method of measuring as a true rating of their entity ‘s worth, but many factors determine their pick as each method has its advantages and restrictions. That ‘s why the IASB Framework says non much approximately measuring as no understanding can be obtained for the best method that can accommodate every company. ( Weetman, 2006 )

As historical cost accounting is based chiefly on the original costs incurred in a dealing, it is a comparatively nonsubjective method. Followings of this accounting rule point to its dependability and objectiveness because the pecuniary sum of the dealing is known. ( Weetman, 2006 ) For this ground besides is hard for the companies to falsely pull strings all the readers, and particularly those who check their histories and fiscal statements, in their favor. It is hard for them to alter the values that are to be recorded in the balance sheet demoing what they want to demo as assets are valued at their cost of purchase or creative activity.

It is an easy method for each company to use and confirmation of all the values presented is truly straightforward as all the paperss, which include all the exact

information about each dealing, already exist in their custodies. This indicates once more that there is no room for use here as bills and grosss are evidentiary for every dealing so there is no uncertainty about balance sheet sums. Another advantage of utilizing historical costs is that it helps the directors to calculate the future operational costs of their companies based on their past information. This function of supplying all this information is of much importance, as non merely the figures are at that place, they are besides really dependable.

However, it is argued that the consequences of utilizing historical cost accounting can be misdirecting. Book values may be based on severely out of day of the month costs. This is happening in times of high rising prices since money is non a stable unit of measuring. The assets are unostentatious and this is because when high rising prices arises the consequence is the autumn in the buying value of money, therefore the assets should be revaluated and the value recorded apprehended and adjusted to the high rising prices. So some acceptances and alterations will necessitate to take topographic point in order for the values to be true and just. If these alterations do non happen the rating of the entity ‘s deserving shown in the balance sheet will non stand for the worth of the company in footings of current value. For illustration, if a company bought some belongings, the sum recorded in the balance sheet is at its historical cost. However this is non the monetary value the company would offer to sell this belongings in the unfastened market. As a consequence this value will non be representative to the market as it does non stand for the market value of the belongings.

Second, companies keeping their capital, are merely concerned with the nominal sum of the capital invested instead its buying power. This arise as a job as capital care is merely done when the fiscal sum of their net assets

at the terminal of the fiscal period is equal to, or exceeds, the fiscal sum of net assets at the beginning of that period. ( Oxford Dictionary, 2005 )

Reacting to the statement above, if utilizing historical cost accounting fixing the balance sheet shows a true rating of the entity ‘s worth, other things being treated the same, my reply is no. In my sentiment, demoing the money as a cost value and non demoing the buying power of the money does non look really logic. Still, a company utilizing an alternate method demoing the buying power of money when it values its assets, its balance sheet does non needfully demo the value of it. Some assets may be given an unrealistic value when revaluated and some intangible assets, such as good will, may be omitted wholly from the balance sheet. This is the ground why I antecedently referred to other things being treated in the same manner, because demoing a just value of your entity ‘s deserving depends on many factors and we can non be cognizant what each company ‘s ‘games ‘ are. However intangible assets losing from the balance sheet might non be a job, merely if their value is recorded in the Net income and Loss history of the company.

In add-on, effects of rising prices may non be the same for all companies in the market and historical cost histories are non so helpful when it comes to compare their corporate public presentation. Critics are stating that this sum in the balance sheet does non

stand for the existent value of the company. If all companies ‘ balance sheets would demo their existent value it would besides be easier for comparing between them and the market.

Over clip the restrictions of using historical costs have been spotted and even though historical cost accounting is flawed, it is the basic theoretical account. Accountants are non

willing to monetary value and value the assets at current market value and accounting organic structures have been made loath to utilize current market values as they have a direct consequence on the portion

monetary values. No other accounting method is supplying such exact information like historical cost accounting. Alternate methods, such as current cost accounting, record alterations in their monetary values which are non based on existent minutess. ( hypertext transfer protocol: // ) They besides open the door for use of the Numberss shown in the balance sheet, where this is non the instance with historical cost accounting. This is why it is said to be the most dependable method, and despite of all its failings it has been recognised and accepted throughout the whole universe. The accounting organic structures recognised that the other methods are flawed as good but they besides know that there is no better replacement. In fact, comptrollers think that rising prices accounting is a waste of clip and are working through direction and revenue enhancement to see how they are able to enter the minutess without worrying about rising prices. ( hypertext transfer protocol: // )

However the Financial Accounting Standard Board ( FASB ) is processing towards just value accounting and off from historical cost accounting. Those opposed, believe that it provides undependable information in the fiscal statements of a company and those

in favour claim that it provides more timely and relevant information despite the increased usage of estimations. ( http: // )

Concluding, ‘providing a true value of your entity ‘s worth ‘ , has a batch of significances. The word ‘true ‘ does non alter its significance but the accounting rules which contribute to this true value alteration with the fortunes. Each company may use its ain method of measuring after pull outing information and doing the suited research on the topic. However historical cost accounting is the best theoretical account and it is the most normally used as it is the lone one which provides definite values.