181PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. ACCOUNTING Financial and Organisational Decision Making Chapter 18 Appraisal of the historical cost system Slides written by Sandra Porritt designed by Tony Van Eekelen

Chapter 18: Appraisal of the historical cost system 18.2 PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. Learning Objectives In this chapter you will be introduced to: –the basis of the historical cost system in its pure form –the strenths of the pure historical cost system in relation to the objectives of financial reporting

Chapter 18: Appraisal of the historical cost system 18.3 PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. Learning Objectives –the weaknesses of the pure historical cost system in relation to the objectives of financial reporting –the major adjustments from the pure system made by the modified historical cost system

Chapter 18: Appraisal of the historical cost system 18.4 PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. –the extent to which financial statements prepared under conventional accounting principles serve their intended purpose Learning Objectives

Chapter 18: Appraisal of the historical cost system 18.5 PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. Introduction Historical cost system Provision of relevant and reliable information for the purpose of accountibility What happens in practice

Chapter 18: Appraisal of the historical cost system 18.6 PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. Objectives for investors and creditors accounting information that is relevant and reliable for decisions to be made information to be free from bias and a faithful representation of events

Chapter 18: Appraisal of the historical cost system 18.7 PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. Relevance Stewardship Performance evaluation Financial stability

Chapter 18: Appraisal of the historical cost system 18.8 PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. Reliability information to be free fom material error and bias implies that the information can be relied on for decision making implies the appropriate measurement of revenue, expenses and valuations of assets and liabilities

Chapter 18: Appraisal of the historical cost system 18.9 PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. The pure historical cost system Assets –original buying price established by actual tranactions –asset values are not changed irrespective of changes in general price level

Chapter 18: Appraisal of the historical cost system PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. Relevance to stewardship refers to the managers responsibility for the protection and the efficient use of the organisations assets

Chapter 18: Appraisal of the historical cost system PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. Relevance to performance evaluation criticism that under inflationary conditions historical cost profit may result in an overstatement of profit failure to account in current terms makes comparison between entities difficult

Chapter 18: Appraisal of the historical cost system PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. Relevance to financial stability problems of capital maintenance and performance measurement a long established firm disclosing large profits may be unable to meet current replacement costs necessary to remain in b usiness

Chapter 18: Appraisal of the historical cost system PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. Reliability despite the weaknesses historical cost rests on its reliability it is a system of primary entries supported by transactions

Chapter 18: Appraisal of the historical cost system PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. Benefits of historical cost system system most used throughout the world based on a simple capital maintenance concept –protects creditors –used by courts to determine what constitutes the company’s capital

Chapter 18: Appraisal of the historical cost system PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. Modifications to historical cost system conservatism or prudence in certain circumstances revaluation of assets upwards

Chapter 18: Appraisal of the historical cost system PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. Influences on accounting practice external reporting influenced by –accounting standards –companies legislation –stock exchange listing requirements –political influence public opinion taxation law

Chapter 18: Appraisal of the historical cost system PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. Conservatism holding losses expenditures (of future benefit) expensed long-term intangible assets - written off expenses deliberately overestimated liabilities may be overstated

Chapter 18: Appraisal of the historical cost system PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. Examples inventory valuation –lower of cost or net realisable value software development costs –policy of expensing costs immediately even though they have future economic benefit

Chapter 18: Appraisal of the historical cost system PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. Claimed advantages of conservatism secret reserves…………………..productive assets depreciated excessively hidden reserves ……………..the difference between historical cost and market value

Chapter 18: Appraisal of the historical cost system PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. Secret reserves asset depreciation allowance for doubtful debts

Chapter 18: Appraisal of the historical cost system PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. Management tools used to produce a stable entity……… higher share value…….. associated advantages……….. improved credit rating ………… lower interest on borrowed funds……...

Chapter 18: Appraisal of the historical cost system PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. Arguments against conservatism misleading to parties takeover bids inefficient management contradicts reliability quality of accounting

Chapter 18: Appraisal of the historical cost system PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. Land held by a company DR Land CR Asset Revaluation Reserve

Chapter 18: Appraisal of the historical cost system PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. Is revaluation beneficial market value disclosclosures reveal hidden asset –current prices = useful information for investment / credit / decisions only when applied consistantly and universally

Chapter 18: Appraisal of the historical cost system PPS t/a Carnegie et al; Accounting: Financial and Organisational Decision Making © 1999 McGraw-Hill Book Co. Aust. Summary Accountants have adopted conservatism in order to overcome the deficiencies of historical cost accounting Opportunities exist for the manipulation to suit some users