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Introduction Accounting concepts and conventions as used in accountancy are the rules and guidelines by which the accountant

lives. For your brief introduction, in accounting, historical cost concepts is the original monetary value of an economic item, it is the original amount of cost and price paid that recorded which does not subjected to future changes. The historical cost accounting is also the situation in which accountants record revenue, expenditure and asset acquisition and disposal at historical cost: that is, the actual amounts of money, or moneys worth, received or paid to complete the transaction. For example, Company A buys a automobile for RM 100,000 three years ago, the value of the automobile is now RM 50,000. However, in company As accounting records, the automobile is still recorded as RM 50,000. So, there is no account is taken of to the increase or decrease in value. However, in a more specified explanation, historical cost is likely an extremely reliable number where all transaction of business entity is recorded at the original cost to the enterprise. Furthermore, historical cost is also known as a significant number because far from embodying some abstract, theoretical notion of value, it reflects an actual price at which an asset was exchanged in a market transaction sometime in the past. For instance, a piece of land purchased years ago at RM 2000000 is still recorded at its original cost even though its value is considerably higher now. In general, costs recorded in the income statement are based on the historical cost of items sold or used, rather than their replacement costs and except in specific cases, assets in a balance sheet are value at historical cost, rather than market value. Historical cost is likely to be the original cost and price of asset, liabilities, and expenses of enterprise that recorded at the time of the transaction. Well, on the other hand, because of its reliability and freedom of bias when compare to fair market value principle, historical cost has long been the backbone of financial reporting. Merits of the historical cost concept Over the years accounting bodies have introduced a number of alternative accounting methods to historical cost accounting such as opportunity cost and replacement cost. However, historical cost account still is the standard form of accounting system and it is a stable measuring unit assumption approved by International Financial Reporting Standards

(IFRS). Due to historical cost unique features and conventions, many companies prefer to use this measurement method for their financial statement rather than using market value method. This is because, over the years, number of cases relating to accounting malpractice and creative accounting have been exposed that have made accounting bodies reluctant from using current values which directly effect the share prices. Showing the asset at its market value will portray the asset at a value which may be inflated or deflated, as the market forces may be. This will defeat the purpose of financial accounting, which involves giving a true and fair view of accounts. Example An area of land was purchased by A company for RM50, 000 in 2005. Today, as on 10th August 2010, the value of that property stands at RM80, 000. In such a case, as per the historical cost principle, the value of this land will be RM50, 000 in the books. Showing it at the inflated price of RM80, 000 will be against the accounting principle of prudence, and it will inflate the profits of the firm, which may influence prospective outsiders. Besides that, historical cost concept is based on recording actual transaction and the figures recorded are reliable, verifiable and free from management bias. Historical cost accounting concept play its role in maintaining the transparency and integrity of financial statements as it provides no spaces of modification and manipulation of the financial data or value of the assets. This is because all the information is supported by evidence such as contracts, invoice, or payment receipts. For example, a car is recorded at value RM 80,000 derived from the invoice. The historical cost system provides managers with a significant range of alternatives in recognizing, reporting and measuring economic information. This information will help the managers to forecast future operation costs based on the past data. If the managers do not know the original cost, the future operation may hinder or hampered. In-addition, using the historical costs concept is simplicity and certainty. This is because this concept provides important cash flow information which is perfectly fits with the cash flow statement and it represent what was paid out for an asset or received in exchange for a liability. Therefore, there is no doubt about balance sheet amount. For example, a land purchased by a company at RM 200,000 will recorded at the value exactly with purchase price in balance sheet. So, when many companies using historical cost method to measure their financial statement, it makes the outsider, such as investor, debtor, creditor and customer can compare the performance from each of the company clearly.

Shortcomings of historical cost concept Historical cost plays a vital role of displaying accurate financial data in cases of stewardship. But, it is not so useful in case of decision making. The cost of acquisition is useful as far as numerical convenience is concerned, but the cost of acquisition does not play any role whatsoever in important financial decisions, for the simple reason that the cost of acquisition cannot be treated as an authentic value of the asset for any given point of time. Historical cost accounts give no indication of current values of the assets of a business. This method of accounting record the acquisition cost of an asset and does not recognize the current market value. There are some company own some asset which is a very old machinery, it still can help the company provide economic benefit inflow, and it is been recorded its original cost in the financial statement, but it maybe not worth a money in current market. It will influence the decision by the management in company and the outsider. They will assume that the company still in great performance because of the maintaining price of the asset. Another main disadvantage is the depreciation charged on historically costed assets is only an inconsistent amount based on out-of-date values and estimated useful economic lives. Depreciation charges do not take into account actual replacement cost of assets at current prices and profit will not reflect the actual cost of trading, which include the replacement of assets at some point in time. Overstating profits by undercharging depreciation based on historical cost, and charging cost of sales at historical cost of inventories can lead to the depletion of an entitys capital through high tax charges and distribution. Thus, it is difficult for shareholders and analysis to assess the real performance and ability of management because changes to current market conditions are not accounted for in the historical valuation basis. Hence, the true valuation of entities is difficult to assess under historical cost rules. Historical costs are only interested in cost allocations and not in the value of an asset. While it tells the user the acquisition cost of an asset and its depreciation in the following years, it ignores the possibility that the current market value of that asset may be higher or lower than it suggests. While historical cost accounting provides a consistent basis for entities to prepare accounts, inflation affects different products and markets. The validity of historical accounting is based on the assumption that the currency in which transactions are recorded remains stable. However, interpretation of accounts over a period of time is difficult because each year relates to different purchasing powers. An asset purchased at a point in time may be

expensive in future. The traditional accounting principles record all assets at an original cost and continue to use these historic figures throughout the asset's life. In addition effects of inflation may not be the same for all the companies in the market and historical cost accounts become almost unhelpful when comparing corporate performance. The asset values for inventory, equipment and plant do not reflect their economic value to the business. Values of stock are normally based on historical costs which mean that the historical closing stock will usually have costs less than its current economic value. This cause the cost of sales to be higher than it would be if the closing stock was revalued at its current costs. Hence the gross profit will be higher and the entity may then pay out a higher level of net profit causing balance sheet to be unrealistic. The relationship of historical cost concept with other concepts Historical cost concepts can work together with the going concern concept. This is because the going concern concept is based on the belief that a business will operate indefinitely. Assets purchased for long-term use, should be recorded at historical cost even if the market value is above or below the original cost. When expenses are prepaid, they should be listed as assets. In the event a business is near the end of its life, this information should be disclosed in the financial statements of a company. Moreover, historical cost concept also must match with the prudence concept. Prudence concepts stated that revenue only when it is earned and also to provide for anticipated losses when they are likely to incur. If the asset is appreciated stated in the market price, it will cause extra profit and goes against prudence concept which never records the revenue until it really exist. Inversely, if the asset is depreciated stated in the market price, it will cause extra losses and goes against prudence concept which never records the expenses until it really exist. So, using the historical cost concept to record assets at the purchased price is matched with the prudence concept. In addition, the historical cost concept also can work with the consistency concept. The purpose of the consistency concept is to assure that financial statements can be easily compared period to period, and therefore to encourage that the same accounting principles be used from year to year. For example, if a company purchased an asset and record the asset at the original cost in the balance sheet, even though there is a change in the value of the asset purchased in the future, the company should record the value of the asset at the historical cost in order to match with the consistency concept.
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Historical Cost V. Fair Value Measurement is a core issue of financial accounting and reporting today. There are two measurement concepts standing against each other: historical costs based on the measurement of assets and liabilities at purchase price (costs) that were incurred at the moment of the purchase, and the fair value measurement based on market prices. Below are the difference between Historical Cost and Fair Value: Identification For historical cost, a historical value is the value that an asset has that justifies that asset being kept. While for fair value, fair market value is the value an asset has when investors are knowledgeable about the asset. Significance Historical value focuses instead on retaining a document. The fair market value is significant because uninformed purchasers might be charged a price different from the fair market value. Function Companies that wish to save space or reduce clutter might look at historical value of documents to determine if the documents should be preserved. Fair market value is used for a variety of purposes such as determining the value of an automobile destroyed in a car accident for insurance purposes. Conclusion As we all know, there is nothings perfect in the world. Everything has its own pros and cons. This also applies to the historical cost concept. Although several limitations and flaws of the traditional historical costs concept have been highlighted, but the accounting bodies cannot ignores that despite all this disadvantages to the historical cost accounting, it has several advantages and it has now been widely recognized and accepted by corporation in today business world. Even if accounting bodies develop a new accounting method or simply pick an existing method to form the standard of accounting, will it be better than historical cost accounting? The answer is no. People are familiar working with the historical costs and that makes it even more difficult for the accounting bodies to replace it. So, in order to prepare a good financial document, the entire accounting concept should inter- related to each other.
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