Accounting theory & Accountability essay on stock exchange
Sharonhy
Powerpointslides-HistoricalCost-21.pptx1
Accounting Theory and Accountability
Measurement - Historical Cost- Module 2
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There is also ‘some’ predictive value in the use of Historical Cost
Using past earnings to predict future profit
Profit as a random walk – best estimate of future is current Profit
Using quarterly and segment data to predict annual profit
Useful in predicting annual profit
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There is also ‘even more’ predictive value in the use of Historical Cost
Using financial ratios to predict financial distress – Eg Current ratio, liquidity ratio
Historical cost accounting information appears to be a good predictor of financial distress
Using past profits to predict future cash flows
Historical cost profits appear to be useful in predicting future cash flows based on cash receipts and cash payments
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Is there ‘some’ objectivity in the use of Historical Cost??
Historical cost is an objective measure yet needs of users is objective and historical cost data is failure
However, application of historical cost model involves:
Estimation can be easily manipulated
Choice of methods (e.g. inventory valuation) eg FIFO/Weighted average
Other subjective judgments - Depreciation
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Is there ‘some’ objectivity in the use of Historical Cost? Here is one example.
Example: Items may be included in the cost of an asset
Requires consideration of all outlays necessary to bring an asset to existing condition and location
E.G. 1: IAS 2/AASB 102 ‘Inventories’ – Para. 10
(a) the cost of purchase
(b) the cost of conversion
(c) other costs
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Example: Other items may be included in the cost of an asset
E.G. 2: IAS 36/AASB 136 ‘impairment of assets’ Para. 6
‘recoverable amount’ of asset
Need to estimate future cash flows and subsequent sale price (judgement)
Estimates required to determine discounted future cash flows from non-current asset
Property/Plant and Equipment recognised at carry amount or recoverable amount
Is there ‘some’ objectivity in the use of Historical Cost? Here is another example.
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There are a range of key ‘criticisms’ of this preoccupation with Historical Cost
Fails to satisfy it’s primary objective (stewardship)
Too many subjective judgments to fulfill the stewardship role?
Information for decision making
The model may lack future focus and therefore relevance for decision making
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There are more ‘criticisms’ of this preoccupation with Historical Cost
Reliance on matching and going concern assumptions
Impossible to accurately match all costs
Going concern fallacy
Notions of investor needs
Distortion of or concealment of important company disclosures – forward looking information is more useful to economic decision making than past results
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How is historical cost applied
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Subjectivity is involved in the determination of the acquisition cost of an item
Thereafter the measurements are even more subjective
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Is there a ‘future’ for the continued use of Historical Cost?
Historical cost is under sustained attack
Increasing use of other valuation models (CCA)
Supported by standard setters
but not necessarily always the case
the case of “creeping” change
Not supported by the business community
More in later topics
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What have we covered today??
Basic concepts support an historic cost approach – does it??
insufficient evidence to justify rejection – really???
satisfies some usefulness and predictive criteria
lacks objectivity
questionable relevance for decision making
distorts stakeholder requirements
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The End
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