"The principle of historical cost is still used in accounting when there is a large measure of agreement that it is inappropriate." Discuss.

1226 Words Oct 12th, 2005 5 Pages

Historical Cost Accounting is a traditional valuation method as it reflects only on the past cost of the asset, however in the contemporary business environment companies must remain flexible and transparent. This belief has lead to the creation of several other valuation methods, due to word constraints I have focused primarily on Fair Value Accounting as an alternative to Historical Cost Accounting. Although Fair value accounting is a theoretically superior valuation methodology, there are several severe problems in its current application, due to lax regulations and ineffective methods of determining current values of non-current assets. These problems within Fair Value Accounting have ensured that most companies
…show more content…
Appropriate valuation of assets without verifiable data can be difficult and subjective. This is especially the case when there is no market for the asset and valuation must be wholly speculative, often leading to unintentional over-valuations of assets.

Furthermore, management using Fair Value Accounting may intentionally over-value assets to improve the financial position of the company, as asset appreciation is recorded as revenue. Watts' (2003, 2) points out that Enron's ability to manipulate 'fair values' and WorldCom's capitalisation of unverifiable unused capacity, were factors in those particular accounting scandals.

Comparison between Historical Cost Accounting and Fair Value Accounting.

Quite clearly historical cost accounting has several limitations and flaws that can have notable influences on businesses and are often criticised. Still historical costs are the standard form of accounting due to its unique features and conventions that make it better than all currently available alternatives.

If markets were liquid and transparent for all assets and liabilities, fair value accounting clearly would be reliable information useful in the decision making process. However, because many assets and liabilities do not have an active market, the inputs and methods for estimating their fair value are more subjective and, therefore, the valuations less reliable. Management bias, whether intentional or unintentional,