Historical Cost Valuation in Real Life

The merits of historical cost accounting and the advantages and disadvantages of the competing alternative measurement systems have been debated vigorously for at least 40 years.  However,  with some rare exceptions,  most companies worldwide still use historical cost.  for example This is not to say that experimentation has not occurred in the Netherlands,  for a Philips,  one of the world’s leading companies,  used replacement cost generation.  Finally,  Philips abandoned replacement cost,  not because of replacement cost’s inadequacies,  but because of the failure of international financial analysts to understand Philips accounts.

Today,  there are still companies in the Netherlands,  such as Heineken,  which use replacement cost.  In the UK too,  there were a few companies,  usually ex-privatized utilities with extensive infrastructure assets,  such as British Gas,  which until recently used replacement costs.  In both the UK and the US in the 1970s,  there were serious attempts to replace historical cost accounting initially with current purchasing,  but later with current value accounting(a mixture of the three current value systems).

These methods were thought to be superior to historical cost accounting when dealing with inflation,  which was at that time quite high.  They were also believed to provide a more realistic valuation of company assets.  In the end these attempts failed.  The reasons for their failure were quite complex.  However,  in general,  accountants preferred the objectivity of a tried-and-tested,  if somewhat flawed,  historical cost system to the subjectivity of the new systems.  In addition,  rates of inflation fell.

Conclusion

Different measurement systems will give different figures in the accounts for profit and net assets.  The mostly widely used measurement system,  historical cost,  records and carries transactions in the accounts at their original amounts.  Historical cost,  however,  does not deal well with changes in asset values resulting from,  for example,  inflation.

Other Four Main Measurement Systems

  1. Current purchasing power adjusts historical cost for general changes in the purchasing power of money.
  2. Replacement cost records assets at the amounts needed to replace them with equivalent assets.
  3. Realizable value records assets at the amounts they would fetch in an orderly sale.
  4. Present value discounts future cash inflows to today’s monetary values.

Although historical cost is the backbone of the accounting measurement systems,  there are departures from it,  such as the valuation of stock at the lower of cost or realisable value.  In particular,  in the UK,  many companies revalue their fixed assets.