Companies have the choice of a variety of methods to value their assets, and they also have the choice to use different methods for different assets (Haskins, Ferris and Selling, 2000). Historical Cost Accounting is a universally recognized accounting model which is preferred by most businesses, but throughout time several models have been proposed to replace or operate along side with historical cost accounting (Elliot and Elliot, 2008), the three methods that will be discussed in this paper are Historic Cost Accounting (HCA), Current Purchasing Power (CPP) and Fair Value Accounting (FVA).
The traditional Historical Cost Accounting records transactions at their original historical monetary cost, any items or an event that has no monetary transaction is usually ignored. Historic cost accounting takes income into account only when revenue is realised in cash or some form which will soon become cash for every period. The profit is calculated through matching costs of items consumed with the generated revenues of the period. A prudent view is taken to value assets (CIMA, 2007).
To illustrate more and understand the Traditional Historical Cost Accounting, an example will be adopted from CIMA publications paper P8 financial analysis:
”Company A acquires a new machine in 20X4. This machine costs $50,000 and has an estimated useful life of ten years,
Company B acquires an identical machine in 20X5, except that it buys a machine exactly one year old, with an estimated useful life of nine years. The cost of the machine is $48,000.
Depreciation charges (straight-line basis) in 20X5 are as follows:
Company A 1/10*$50,000= $5,000
Company B 1/9*$48,000= $5,333
Net Book values at the end of 20X5 are:
Company A $50,000-(2*, 5000) = $40,000
Company B $48,000-$5,333= $42, 0000”
(CIMA Publications, 2007, Paper P8, Financial analysis Pg. 243)
According to historical cost accounting, even though both companies use the same machine in 20X5, the income statement will show different profit figures, and the statement of financial position will show different Assets figures (CIMA, 2007).
The historical cost accounting is principally an objective accounting system; its nature is easily understood and is always supported by documented evidence, such as invoices. Therefore Historical Accounting is undisputedly verifiable. Furthermore one of the main characteristics of historical cost accounting is that the profit concept used in HCA is generally easy and well understood (Elliot and Elliot, 2008).