Tuesday, March 7, 2017

What are the disadvantages of historical cost model in accounting?

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.
hitorical cost model

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

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