Limitations of Historical

Cost Accounting
 Historical Cost Accounting
 Is the situation in which accountants
record revenue, expenditure and asset
acquisition and disposal at historical cost:
that is,
 The actual amounts of money, or money's
worth or the fair value of the consideration
given to acquire them at the time of their
acquisition , received or paid to complete
the transaction.
Limitations of Historical
:Cost Accounting include
 Control
 Consumption
 Taxation
 Valuation
Control
 The prime objective of the
preparation and publication of
:regular financial reporting is

 Provide information for the shareholders

about the progress of the company to
be assured that the company achieved
its objectives.
 And to be assured that the
management uses the company
recourses in effective way as the
shareholders wish.
Stewardship
Is narrowly defined to cover simply the
reporting by directors to shareholders of
how they have used shareholders funds.
If the board of directors uses
the method of stewardship
:then
 It is possible to argue that historical cost
accounting is reasonably adequate.
 A historical cost balance sheet lists the
assets of the company and the liabilities
on the company; however it will not
identify all the assets, as it will usually
omit many intangible assets such as the
skill and knowledge of the employees.
control
 Historical cost accounts, in general,
simply show the acquisition cost or the
depreciated historical cost of a
company’s assets and not their current
value, let alone the value of the
company as a whole. So historical cost
accounting do not provide an absolute
measure of success of the company.
control
 The historical cost accounts are most
unhelpful when it comes to the
comparison of performance because the
inflation which means general increase
in price or fall in value of money affect
different companies in very different
way and the problem is not just inflation
but includes the treatment of changes
in relative price.
Consumption
Consumption
 Empirical evidence suggests that
companies' dividends are related to the
level of the reported profit.
 The concept of capital maintenance
based on historical cost accounting
principles has proved to be a dangerous
benchmark when used to assess the
amount which a company can pay out
by way of dividend or through taxation.
Consumption
 Distribution decisions should be made
on the basis of consumption needs and
perceived future investment
opportunities inside and outside the
company, and in many cases it would
be sensible not to restrict distribution to
profits.
Taxation
Taxation
 The company tax charge is based on its
accounting profit, the higher the
amount that will be paid in tax.
 The historical cost accounting does not
constitute a suitable basis for the
computation of the taxation obligations
of business.
Taxation
 The use of historical cost accounting as
the basis for taxation means that in
period of rising prices the proportion of
the increase in company wealth which is
taken by taxation may be very much
larger than that which is implied by the
nominal rate of taxation.
Taxation
 The rapid and extreme inflation of the
mid-1970 made government and others
very much aware of the inadequacy of
historical cost accounting for the
purpose of taxation.
Valuation
Valuation
 The knowledge of historical cost of a
company asset will not be of much help
in assessing the value of a company or
its shares in a business; hence, it is
better using current value principle to
valuate the company.
Alternatives to Historical
Cost Accounting
 Replacement costs.
 current cost accounting.
 Exit price method.
The End

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