Question

Mautz (1973) made the following comment: “Accounting is what it is today not so much because of the desire of accountants but because of the influence of businessmen. If those who make management an investment decisions had not found financial reports based on historical cost useful over the years, changes in accounting would long since have been made” Critically evaluate this statement. In your discussion, you should consider the relative merits of historical cost accounting as well as the various alternative measurement systems that have been proposed.

Answer 1

Accounting is the language of business which provides the information on financial status and performance of the entity to the users of financial statements. Over the years accountants have adopted a variety of methods in the preparation of financial statements. The Historical cost also known as C onventional accounting holds that the elements of financial statements be reported based on their initial cost of acquisition.The historical cost accounting is based on the realisation principle which requires that only realised revenues be included in the income statement. In the balance sheet the realisation principle requires adherence to the historical cost of the asset untill the asset is sold despite changes in its value. Accounting data under historical accounting are generally considered free from bias and more reliable by external users and investors as they can be easily verified with the help of documentary evidence . Accounts under this system are free from personal judgement of the preparer and therefore less disputable than other accounting systems, more preferred by the business community and hence advocated by Mautz as per the referred comment. Berkin said if business income would arbitrarily be adjusted to show the impact of inflation, labour would be in an untenable bargaining position. Historical accounting is also advocated on the ground that it is the only legally recognised accounting system accepted as a basis for reporting capital, taxation, dividend declaration, etc. The conventional method of accounting is also supported as it is till now considered the least costly to the society.

However this convention method is under severe crticism in this era of inflation and ever changing market conditions as it has its own limitations. It assumes that there is either no inflation or inflation can be ignored which is not correct. In times of inflation the purchasing power of money changes thus true values of the business enterprise are not communicated. Current revenues are not measured with current costs as costs are both historical and current. Costs like depriciation are historical, inventory costs are recent and costs such as salaries wages and distribution costs are current. Thus there is an absence of uniformity and the same base. And hence profits may not give the true picture leading to anomalies in dividend distribution, settlement of wage claims, excessive taxation, underpricing of sales, misinformation to the management business community and investors.

HCA is defended on the grounds of its assumed objectivity but this objectivity does not hold very strong as there are varous methods available for computing depriciation, inventory etc. As an alternative Current value accounting which advocates introducing current costs rather than historical costs in accounting was recommended. Under this method reporting entity is required to value its assets and liabilities at current values thus eliminating holding gans and losses.This provides better insight into management credibilty and also makes inter firm comparisons more real as they are all valued at current market values. However this method too has its problems like making accounting costly and difficulties in collecting information, high level of subjectivity and estimation leading to significant measurement error and moral hazards.

Thus there are controversies with different methods of accounting, what is to be remembered is that accounting is a service function and it is a useful tool for the society. Hence the objective should not be defeated and it must cater to the changing needs of the society.