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PUTRI ROUDINA MASUD / 041411331084

CONVENTIONAL ACCOUNTING

BASIC CONCEPTS
Objective of Accounting
A large enterprise has caused a separation between owners and managers. That is, the firm has an identity
of its own, separate and distinct from owners, creditors, and all other interested parties.
According to the stewardship function of managers must be the focus of attention of accountants in
reporting to external parties. Owners and creditors are primarily concerned about what management has
done with the funds entrusted to them.
Accounting theory therefore should explain the concepts of revenue and expense in terms of enterprise
asset-changes rather than as increases or decreases in stockholders equity.

Income
From the traditional point of views, revenues indicate the accomplishments of the firm for the given
period, expenses represent the effort expended, and income is correlated with the effectiveness of the firm
as an operating unit.
Income is a measure of the performance of the managers in handling the resources entrusted to their care
and use. The income statement reveals the result of the operations of the enterprise.

Cost Attach
Traditional accountants believe that it is justifiable to use historical cost and to allocate its amount, even if
the replacement cost has risen. Therefore, the cost attach has been formulated.
There are two types of cost: displacement and embodied.
Displacement cost denotes what has been given up and sacrified, synonymous with opportunity cost.
Embodied cost or absorption cost, relates to the factors of production and has to do with what goes into
something.
To determine the cost of one product, one simply needs to add up all the attached cost to that particular
product. The total of all those attached costs represents the effort expended to produce it, not the value of
the product. Therefore the costs attach theory is fundamental in cost accounting.
But, economists do not accept this theory. They believe there is only one kind of cost, a sacrifice.

Flow of Cost
The accountants job is to keep track of the flow of cost, trace the movement of those costs as they flow
through the business to achieve the objective of the firm, which is to make a profit.
The accountant must decide which costs have expired and to be matched against revenues on the income
statement. They also determine the unexpired costs which are to be placed on the balance sheet as assets.
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The matching principle is critical point which guides the accountant to decide which costs are to be
considered as expenses.

DEFENSE OF HISTORICAL COST


1. Historical cost is relevant in making economic decisions. As managers make decisions concerning
future commitments, they need data on past transactions. They must be able to review their past
efforts, and the measure of those efforts is historical cost.
a. Historical cost affects the evaluation and selection of decision rules because it directly related
to past decision. It also serves as a basic for forecasting the future prices.
b. It provides input to the satisficing notion.
c. It is imposed on the decision maker by his environment.
2. Historical cost is based on actual, not merely possible, transactions. A recording of the actual
transaction is made and therefore there is a supporting record on the financial statement. Records
of the past transactions are necessary for accountability.
3. Financial statements based on historical cost have been found to be useful.
4. The concept of profit is the excess of selling price over historical cost.
5. Historical cost is less subject to manipulation than current cost or selling price.
6. If the price of an asset at the end of the year is lower than it was during the year, this encourages
critism of management by stockholders for not having disposed of the asset earlier. Thee are
important reasons for holding an asset other than realizing an immediate profit.
7. Historical cost does not differ materially from current cost.
8. Insufficient evidence to justify rejection of historical cost accounting.

CRITISMS OF CONVENTIONAL ACCOUNTING


1. Stewardship is narrowly constructed. People want accounting information for decision-making
purposes. They wish to make predictions about the companys future cash flows. The more current
the information, the more relevant it is. Therefore, using historical cost is not a logical
consequence of the objective of accounting.
2. The assertion that historical cost attach to goods and services is based on fiction.
3. The task of deciding which costs have expired and which have not is basically arbitrary, because
making such judgment is virtually impossible. It is inconsistent also to argue that costs move
through the company and gradually expire, whereas revenues suddenly appear, usually on the date
the output is sold.
4. Most people believe that conventional accounting financial statements are sufficient, although
some additional data could be included.