| Accountancy | |
|---|---|
| Key concepts | |
| Accountant · Accounting period · Bookkeeping · Cash and accrual basis · Cash flow forecasting · Chart of accounts · Journal · Special journals · Constant item purchasing power accounting · Cost of goods sold · Credit terms · Debits and credits · Double-entry system · Mark-to-market accounting · FIFO and LIFO · GAAP / IFRS · General ledger · Goodwill · Historical cost · Matching principle · Revenue recognition · Trial balance | |
| Fields of accounting | |
| Cost · Financial · Forensic · Fund · Management · Tax (U.S.) | |
| Financial statements | |
| Balance sheet · Cash flow statement · Statement of retained earnings · Income statement · Notes · Management discussion and analysis · XBRL | |
| Auditing | |
| Auditor's report · Financial audit · GAAS / ISA · Internal audit · Sarbanes–Oxley Act | |
| Accounting qualifications | |
| CA · CPA · CCA · CGA · CMA · CAT · CFA · CIIA · IIA · CTP · ACCA |
In accounting, historical costs is the original monetary value of an economic item.[1] Historical cost is based on the stable measuring unit assumption. In some circumstances, assets and liabilities may be shown at their historical cost, as if there had been no change in value since the date of acquisition. The balance sheet value of the item may therefore differ from the "true" value.
While historical cost is criticised for its inaccuracy (deviation from "true" value), it remains in use in most accounting systems. Various corrections to historical cost are used, many of which require the use of management judgment and may be difficult to implement or verify. The trend in most accounting standards is a move to more accurate reflection of the fair or market value, although the historical cost principle remains in use, particularly for assets of little importance.
Depreciation affects the carrying value of an asset on the balance sheet. The historical cost will equal the carrying value if there has been no change recorded in the value of the asset since acquisition. Improvements may be added to the cost basis of an asset.
Historical cost does not generally reflect current market valuation. Alternative measurement bases to the historical cost measurement basis, which may be applied for some types of assets for which market values are readily available, require that the carrying value of an asset (or liability) be updated to the market price (mark-to-market valuation) or some other estimate of value that better approximates the real value. Accounting standards may also have different methods required or allowed (even for different types of balance sheet variable real value non-monetary assets or liabilities) as to how the resultant change in value of an asset or liability is recorded, as a part of income or as a direct change to shareholders' equity.
The Constant Item Purchasing Power Accounting model is an International Accounting Standards Board approved alternative basic accounting model to the traditional Historical Cost Accounting model.
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Under the historical cost basis of accounting, assets and liabilities are recorded at their values when first acquired. They are not then generally restated for changes in values.
Costs recorded in the Income Statement are based on the historical cost of items sold or used, rather than their replacement costs.
For example –
At the end year 1 the asset is recorded in the balance sheet at cost of $100. No account is taken of the increase in value from $100 to $120 in year 1. In year 2 the company records a sale of $115. The cost of sales is $100, being the historical cost of the asset. This gives rise to a profit of $15 which is wholly recognised in year 2.
It is standard under the historical cost basis to write down the value of inventory (stock) to a lower cost and net realisable value.[2] As a result:-
Property, plant and equipment is recorded at cost under the historical cost basis.[4] Cost includes:-
In IFRS, cost also includes the initial estimate of the costs of dismantling and removing the item and restoring it. Cost may include the cost of borrowing to finance construction if this policy is consistently adopted. Cost is then subject to depreciation with to write off the cost of the asset over its estimated useful life down to the recoverable amount.[5] In most cases the method is "straight line", with the same depreciation charge from the date when an asset is brought into use until it is expected to be sold or no further economic benefits obtained from it, but other patterns of depreciation are used if assets are used proportionately more in some periods than others.
Monetary items such as cash balances, receivables and payables which are denominated in foreign currency are reported using the closing exchange rate under IFRS.[6]
Under IFRS it is acceptable, but not required, to restate the values of property, plant and equipment to fair value.[7] ‘Fair value’ is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm's length transaction. Such a policy must be applied to all assets of a particular class. It would therefore be acceptable for an entity to revalue freehold properties every three years. The revaluations must be made with sufficient regularity to ensure that the carrying value does not differ materially from market value in subsequent years. A surplus on revaluation would be recorded as a reserve movement, not as income.
Under IFRS and US GAAP derivative financial instruments are stated at fair value (“mark to market”) with movements recorded in the income statement.[8][9]
IFRS requires a separate method of accounting in currencies deemed to be hyperinflationary.[10] The characteristics of a hyperinflation include the population keeping its wealth in non-monetary assets or relatively stable foreign currencies, prices quoted in foreign currencies or widespread indexation of prices. This might arise if cumulative inflation reaches or exceeds 100% over three years. An entity operating in a hyperinflationary economy:-
In management accounting there are a number of techniques used as alternatives to historical cost accounting including:-
The IASB's Framework introduced Constant Item Purchasing Power Accounting as an alternative to Historical Cost Accounting in 1989 in Par. 104 (a) where it states that financial capital maintenance can be measured in either nominal monetary units - the traditional HCA model - or in units of constant purchasing power at all levels of inflation and deflation: the CIPPA model.[11]
The specific choice of measuring financial capital maintenance in units of constant purchasing power (the CIPPA model) at all levels of inflation and deflation as contained in the Framework for the Preparation and Presentation of Financial Statements, was approved by the International Accounting Standards Board’s predecessor body, the International Accounting Standards Committee Board, in April 1989 for publication in July 1989 and adopted by the IASB in April 2001.
“In the absence of a Standard or an Interpretation that specifically applies to a transaction, management must use its judgement in developing and applying an accounting policy that results in information that is relevant and reliable. In making that judgement, IAS 8.11 requires management to consider the definitions, recognition criteria, and measurement concepts for assets, liabilities, income, and expenses in the Framework. This elevation of the importance of the Framework was added in the 2003 revisions to IAS 8."
IAS8, 11:
“In making the judgement, management shall refer to, and consider the applicability of, the following sources in descending order: (a) the requirements and guidance in Standards and Interpretations dealing with similar and related issues; and (b) the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the Framework.”
There is no applicable International Financial Reporting Standard or Interpretation regarding the valuation of constant real value non-monetary items, e.g. issued share capital, retained earnings, capital reserves, all other items in Shareholders Equity, trade debtors, trade creditors, deferred tax assets and liabilities, taxes payable and receivable, all other non-monetary receivables and payables, Profit and Loss account items such as salaries, wages, rents, etc. The Framework is thus applicable.
The CIPPA model is chosen by hardly any accountant in non-hyperinflationary economies even though it would automatically maintain the real value of constant real value non-monetary items, e.g. issued share capital, retained income, other shareholder equity items, trade debtors, trade creditors, etc., constant for an unlimited period of time in all entities that at least in real value at all levels of inflation and deflation - all else being equal. This is because the CIPPA model is generally viewed by accountants as a 1970's failed inflation accounting model that requires all non-monetary items - variable real value non-monetary items and constant real value non-monetary items - to be inflation-adjusted by means of the Consumer Price Index.
The IASB did not approve CIPPA in 1989 as an inflation accounting model. CIPPA by measuring financial capital maintenance in units of constant purchasing power incorporates an alternative capital concept, financial capital maintenance concept and profit determination concept to the Historical Cost capital concept, financial capital maintenance concept and profit determination concept. CIPPA requires all constant real value non-monetary items, e.g. issued share capital, retained income, all other items in Shareholders Equity, trade debtors, trade creditors, deferred tax assets and liabilities, taxes payable and receivable, all items in the profit and loss account, etc. to be valued in units of constant purchasing power on a daily basis. Variable real value non-monetary items, e.g. property, plant, equipment, listed and unlisted shares, inventory, etc. are valued in terms of IFRS and updated daily.
The IASB requires entities to implement IAS 29 which is a Constant Purchasing Power Accounting model during hyperinflation.
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