1. Measurement Model Historical Cost Current Cost (CAA) Prepared by:
Carly Wong
Ingrid Yeung
Carmen Wong
Priscilla Wong

2. Historical Cost Model

3. Historical Cost Model The model has been around since the 1400’s
Until after WWII, inflation was not really part of our economic environment
The essence of the model is that all transactions are recorded at their acquisition or original cost

4. Historical Cost Model (Cont’d)
Form of payment is irrelevant
Assumes aggregation of monetary units from different periods acceptable
Acquisition cost of depreciable assets is allocated over asset’s effective service life
Historical cost depreciation is matched against current dollar revenue creating an illusory net income component

5. Argument for Historical Cost

6. Historical cost is relevant in making economic decisions
Decisions making concerning future commitments => need data on past transactions as the basis for judging
History cost is relevant for decision making
Affecting evaluation and selection of decision rules
=> historical cost is directly related to past decisions
=> determine the quality of the past decision
=> serve as a basis for the forecast
2. Providing input to the “satisficing” notion
=> decision makers do not seek to optimizes but to satisfice
=> consider how much earned rather than how much can earn

7. Historical cost is relevant in making economic decisions
3. Imposing on the decision maker by their environment
=> employed many different contexts
e.g. taxable income , cost-plus contracts

8. Historical cost is based on actual, not merely possible transactions
Record of the actual transactions
=>supporting documents are provided
=>determining how effectively management has met its responsibilities
=>increasing the accountability-primary objective under stewardship function
Current cost or exit price accounting
Basis of year end market prices without reference to actual transactions

9. Throughout history, financial statements based on historical cost have been found to be useful
Financial reports based on historical cost useful for over the years
Modern industrial and managerial accounting practices based on trial and error for many years
=> not useful => changed

10. The best understanding concept of profit is the excess of selling price over historical cost
Profit is accepted as a measure of successful performance
Profit requires sufficient use of time , place and form be added to the materials, products or services purchased above the cost
Historical cost is the basis idea of profit
E.g. decision on whether continue a product line or not depends on the favorable spread between revenue and cost

11. Accountants must guard the integrity of their data against internal modification
Historical cost is less subjective to manipulation than current cost or selling price.
Littleton => these are still wholly outside the prior decisions and the recorded experience of the enterprise

12. Accountants must guard the integrity of their data against internal modification
Mautz => whom would you trust to value the assets of any major company, how are current values to be determined, how would an accountant ascertain that the values are a fair presentation, can an accountant withstand the pressure by managers to accept optimistically valued assets?

13. How useful is income information based on current cost or exist price
Is it useful to show as income an increase in the value of an asset that the firm has no intention of selling?
If the price of an asset at the end of the year is lower than it was during the year, this encourages criticism of management by shareholders for not having disposal of the asset earlier.

14. How useful is income information based on current cost or exist price
Current cost and exist price accounting induce a short-term view of profits.
In many cases, management may believe that disposing of assets is not the more profitable alternative – reasons for holding an asset other than realizing an immediate profit.

15. Changes in market prices can be disclosed as supplementary data
Historical cost does not differ materially from current cost.
Supplementary data on current prices are a practical and sufficient way of dealing with such information without having to shift from historical cost to a current cost basis.
Adopted by the Australian Accounting Standard setters in 1976.
Supplementary statement in addition to their conventional financial statement

16. Changes in market prices can be disclosed as supplementary data
Based on studies of the relationship between accounting data and the market reaction to the data, the efficient markets hypothesis in semistrong form states that security prices always reflect publicly available information.
Implying that the method of disclosing any information including current values, whether shown in the text of the financial statements, as a footnote, or as supplementary data, makes no difference to the market.

17. There is insufficient evidence to justify rejection of historical cost accounting
Most of the research studies indicate that current cost data do not provide any more information than historical cost data
Traditional accountants argue that there is no persuasive empirical evidence that indicates that current cost or exist price accounting information is more useful than historical cost information

18. Criticisms of historical cost accounting

19. Objective of accounting
Provide useful information for economic decision making is taken to mean providing information to the stewardship function of management.
Historical cost accounting reveals that the primary role of accounting is to meet the decision-making needs of users
Forward-looking decision-usefulness approach

20. Objective of accounting
Information on the stewardship function does not necessarily restrict accountability to the original amounts invested directly or indirectly by equityholders.
Investors are interested in knowing about the increases or decreases in the value of their investments as represented by the net assets of the company

21. Objective of accounting
Historical cost system fails in its underlying function of providing objective information.
It is far from objective and is open to manipulation
Monograph 10 questions the validity of the historical cost information and attacks a basic tenet of the system, which is that historical cost information ensures the maintenance of an entity’s capital base.

22. Information for decision making
Historical cost=> management needs historical cost data in order to evaluate their past decisions as they contemplate future commitments
Past decision was right or wrong must ultimately be ascertained by what happens in the marketplace
Historical cost has usefulness, but it is insufficient for the evaluation of business decisions.

23. Information for decision making
Historical cost accounting adopts a financial capital concept.
However, capital regarded as the nominal dollar investment in the firm rather than the purchasing power of the investment. After the year of acquisition, historical costs do not correlate with the events of the year.

24. Information for decision making (Cont’d)
Historical cost overstated income in a time of rising prices because it offsets historical cost against current inflated revenue.
Highly questionable for the relevance of historical cost for decision making.

25. Basis of historical cost
Historical cost is under the ‘going concern’ assumption
Sterling => questions the validity of the assumption
The high rate of business failure would make it difficult to build an evidential case for a projection of continuity. No business has ever continued ‘indefinitely’ into the future.

26. Historical cost under attack
Balance sheets contain outdated cost prices or valuations => hardly to say to be true and fair
A lot of departures
All non-financial assets of GTEs be measured using ‘deprival value” concepts
Liabilities be measured using present value
Departures provide more relevant information than historical cost

27. Notions of investor needs
Historical cost cause either a distortion or concealment of important company disclosures=> goal of conventional accounting are ill-conceived
Because accountant:
Have naïve, simplistic view of investor and their needs
Accept old-fashioned, fundamentalist view
Share market analysis and corporate analysis are different
Market analysis mainly of trying to ascertain what other investor are thinking
Corporate analysis not really concerned about corporate facts but about the psychology of the market

28. Matching
Going concern assumption does not underlie the use of historical cost
Matching concept-when revenues are earned, the expenses incurred in earning those revenues are matched (offset) against the revenues to calculate income
Conventional accounting puts emphasis on deciding whether a cost should be deducted form revenues in the current period or be deferred to future periods
=>responsible for deferred charges and that are not assets and deferred credits that are nor liabilities

29. Matching Decisions are based on the matching principle
=> in most cases the matching of costs and revenues is a practical impossibility
e.g. cost allocation- not capable of being verified or refuted because there is no way to select one method over another except arbitrarily

30. Current Cost Accounting (CCA)

31. Definition of current cost accounting
a cost calculated to take into consideration current circumstances of cost and performance levels
adjusting to constant purchasing power by using the average inflation rate in the current year

32. Business Profits composes into 2 parts Current operating profit:
realizable cost savings
Current operating profit:
excess of the current value of the output sold over the current cost of the related inputs
 Realizable cost saving:
increase in the current cost of the assets held by the firm in the current period
both realized and unrealized cost changes.

33. Business Profits realizable cost savings = holding gains/losses
Holdings gains:
a saving attributable to the fact that the input was acquired in advance of use
this savings is attributable to holding activities.

34. Why we need to measure separately?
Holding assets and liabilities  enhance the firm’s market position
managers and others want to know if these holding activities are successful
Under the conventional accounting  gains are only recorded when the assets are disposed  impossible to show it unless assets are bought and sold  mislead the investor to determine which firm is more efficient

35. Assumption of the CCA
Without the measurement of the holding gains/losses
 confuse the evaluation of management decision
 hinders the allocation of resources in the economy
 CCA suggest that separation of holding gains and operation profits gives credit to the appropriate managers

36. Financial Capital Concept vs. Physical Capital Concept
CCA provides more useful information than conventional accounting
supports can be divided into 2 camps
those who believe in the financial capital concept
those who believe in physical capital concept
Difference: “whether or not holding gains or losses are included in income” 

37. Financial Capital
firm invests financial resources with the expectations that the investment will create a higher level of cash inflow
recovery of the amount of financial resources invested is a return of capital
cash flows in excess of the amount financial resources invested are a return on capital
holding gains cost savings and the increases in future cash flow of the assets

38. Physical capital
physical units denoting the firm’s operating capability
emphasize on the need to know the firm’s operating capability has been maintained  continue in businesses
the holding gains capital maintenance adjustment

39. Argument Against CCA Realization principle
it violates the traditional realization principle
because the changes in market price of the assets in use is irrelevant
fixed asset is not more valuable to a firm simply because its current cost has risen
asset value lies in its service potential, not its market value

40. Argument Against CCA (Cont’d)
Subjectivity
another problem is the subjectivity of determining the amount of the increase in cost
if there is no reliable secondhand market, current cost must be the new asset expected to replace the old one
adjustment has to be made between the actual asset and the replacement
it is difficult to calculate

41. Argument Against CCA (Cont’d)
Subjectivity
another problem is the subjectivity of determining the amount of the increase in cost
if there is no reliable secondhand market, current cost must be the new asset expected to replace the old one
adjustment has to be made between the actual asset and the replacement
it is difficult to calculate

42. Argument Against CCA (Cont’d)
viewpoint of exit price
cost implies opportunity cost or sacrifice of the next best alternative
current sacrifice faced by a company is to sell the asset rather than use it
but not to purchase the item because company has already owned it
so current cost, which is the price to purchase, is irrelevant

43. Argument Against CCA (Cont’d)
Allocation problem
allocation of current cost is arbitrary and lack in real-world counterparts
backlog depreciation is charged to income or to a capital account
cause difference in amount of income reported

44. Argument Against CCA (Cont’d)
Technological changes
improved assets will more than likely replace existing assets
so current operating profits would be poor predicators of future profits
investors would be misled by the current operating profit as a basis for predicting future cash flows

45. Argument Against CCA (Cont’d)
Sum up:
current cost information is irrelevant to most investment decisions
it does not focus on the firm’s ability to command financial resources in the firm’s quest to adapt itself to the environment

46. Argument For CCA Recognition principle
current cost accounting violates the conventional principle of recognizing a holding gain only for unrealized holding gains from a financial capital view
unrealized holding gains represent actual economic phenomena occurring in the current period
therefore should be recognized if there is sufficient objective evidence to support the price changes

47. Argument For CCA (Cont’d)
Recognition principle (cont’d)
market price of fixed assets are not relevant
however, whether the firm intends to use or sell a fixed asset is not pertinent
the change in the price of the asset is relevant
determination of periodic income should be based on what actually happened in the current period, not on what might occur

48. Argument For CCA (Cont’d)
Subjectivity
current cost accounting lacks objectivity?
current cost is not based on actual transactions in which the firm is a participant
however, objectivity is relative
even under conventional accounting, some figures are more objective
therefore, the question is whether current costs meet a certain minimum level of objectivity that the accounting profession is willing to accept

49. Argument For CCA (Cont’d)
Subjectivity (cont’d)
market prices are relatively easy to obtain
the objectivity of their current costs would be acceptable
E.g current cost of fixed assets can be obtained from secondhand dealers
No market prices are available
appraisals, calculations of reproduction costs and use of index numbers

50. Argument For CCA (Cont’d)
Viewpoint of exit price
Value at exit price is unusual because the firm is normally a buyer
utilizing exit prices when liquidation is not contemplated is misleading
e.g. a customized asset used by the company is of great value, but when a firm is under liquidation, the value of the asset is greatly reduced as it is customized for the company’s own use

51. Argument For CCA (Cont’d)
Viewpoint of exit price (cont’d)
however, the company decides to keep and use its assets rather than sell the asset
because the management of the company believes its value in use is greater than its exit value

52. Argument For CCA (Cont’d)
Allocation problem
allocation problem exists in most accounting method, even the conventional historical cost accounting also has the allocation problem

53. Argument For CCA (Cont’d)
Technological changes
current operating profit = indication to make a positive long-term contribution to the economy
it also indicates that the production process in use by the firm is effective
if profit > interest earned on the net assets at current cost
the existing production process is worth continuing

54. Argument For CCA (Cont’d)
Technological changes (cont’d)
current operating profit is primarily representative of the long-term profit capability of the firm under the existing production process, assuming that existing conditions remain relatively the same
the technological changes are not taken into account
When a new machine changes the cost of production, the price of the old must adjust
the price of the old asset reflects the technological change

55. Conclusion
current cost accounting performs significantly better than historical cost income
because historical cost accounting fail to adjust for inflation
No doubt, CCA data provide useful information to managers

56. Conclusion (Cont’d)
Question: whether benefits exceed the cost of gathering the information?
On a cost-benefit basis
historical cost information are almost provided in the capital markets
Objectivity:
information obtained from genuine transaction that have occurred
Information is capable of being verified
Conclusion: Historical Cost Accounting is better