Before
we look deep into this concept, let’s have a look into what exactly is
historical cost and how it has disadvantages in accounting. Historical cost is
basically the original cost of any product or asset which a company has to bear
at the time of purchase. It can also be termed as a term cost and is usually
used in the system called generally accepted accounting principles method. This
particular cost helps in distinguishing the cost from its replacement cost, or
inflation adjusted cost. In short it is the original nominal monetary value in economic concepts. Now the question arises
that whether there are any advantages and disadvantages of using historical
cost model in accounting or not? And if not historical model, then are there
really any alternatives to this particular model which can help in accounting
computation.
How
useful is historic cost model in accounting?
Historic
cost model has one super advantage over all other models that it has defined
objectivity and is free from all perspectives. Here the best advantage is that
original cost is recorded and therefore least manipulation is involved. This
seems very advantageous, but every coin has two sides and so is this. It has
many disadvantages when used in accounting. It has number of limitations in
economics. It lacks the basic concept of market price change. No asset is of
fix value at any point of time. And so is this. It calculates things on basis
of fixed values, which is hypothetical and unrealistic. This method never gives
a true and fair picture of the whole scenario. The other issue is the
unrealistic profit reflection, because this concept does not include the
situations related to depreciation or inflation, which are very much true in an
economy. In this model, whether an asset is on hold or is being operated,
everything is considered equal, which is again an unrealistic situation. The
balance sheet in this particular model does not show non-monetary assets with
their true value, so even it cannot be considered an optimized balance sheet.
Final
thoughts
There
are many disadvantages of historical cost model in accounting.
See Also:
Inventories are non-monetary product
Foreign Currency Effects
