Question

Question 2 - 750 words Identify the weaknesses of historical cost accounting. Were any of the alternatives to historical cost (CPPA/CoCoA/CCA) successful? In your response you will need to outline your criteria for success.

Answer 1

Part 1

Historical Cost Accounting (HCA) is the conventional accounting where accounting records are maintained at original transaction price.

In economic environment, the weaknesses of historical cost accounting are –

1. It does not consider price level changes. Hence, it failed to give true and fair view of financial affairs of organization.
2. It ignores inflation factor. As a result, Income statement reflects over-stated, unrealistic profit.
3. Monetary figures of assets in financial statements are outdated. Assets reflect the cost at the time of acquisition. It doesn’t consider current market price.
4. It leads to a wrong inter period comparisons of performance and growth of organization.
5. It doesn’t match current revenues with current cost.
6. It mixed up holding gains and operating gains. To get a fair operating profit, it is important to segregate holding gain and operating gain.

Part 2

CPPA or Constant purchasing power accounting follows price index system.
It re-states historical figures at current purchasing power.
Thus it is successful in recognizing the criteria of -
1. Price level changes
2. Inflation factor
3. Accounting Comparability
and
4. Distinguish operating profits.

But,
1. It considered general purchasing power, not the changes in value of individual items.
2. It is based on statistical index which is not suitable for an individual firm.
3. It is difficult to choose a right price index
4. There is no major departure from conventional accounting. The basic principles of historical cost accounting remains operative under CPPA. So, it fails to remove all defects of HCA.

For above reasons, the success of CPPA is questionable.

CoCoA or Continuously Contemporary Accounting measures assets and liabilities at their current cash price. It is based on current selling price of existing assets.
The statement of financial position is considered to be the prime financial statement.

It is successful in recognizing the criteria of -
1. Price level changes
2. Inflation factor
3. Up-to-date figures of fixed assets in financial statements
4. Effective allocation of Depreciation cost

But, There are some limitations -
1. Not all assets will have a readily determined market price
2. It takes general market price of a particular asset but one asset can generate income to a particular entity and it may generate zero income to another. So, value of an asset varies entity to entity.
3. Difference between cost of assets and the net market value will dominated the result of net profit.

It is also expensive system. So, Success of CoCoA as an alternative to HCA is debatable.

CCA or Current Cost Accounting values assets at their fair market value. It takes into account time-value of money and inflation.
It is successful in recognizing the criteria of -
1. Price level changes
2. Inflation factor
3. Distinguish operating profits and Holding Profit
4. Effective allocation of Depreciation cost etc.

Theoretically, CCA is most successful alternative method to HCA but
1. It is difficult to determine the right fair market value.
2. The operating profits computed on the basis of CCA cannot be said to reflect the real earnings.

But, in spite of these drawbacks, CCA is considered as a better alternative to HCA.