The Effect of Historical Cost Accounting on the Reported Profit of a Company an Evaluation of Current Cost Accounting as an Alternative Reporting Method
CHAPTER ONE
Objective of the study
The primary objective of this study is to investigate the effect of historical cost accounting on the reported profit of a company and to evaluate current cost accounting as an alternative reporting method. Specifically, the study aims to achieve the following objectives:
- Analyze the extent to which historical cost accounting affects the reported profit of a company by comparing financial statements prepared using this method with those adjusted to reflect current market values of assets.
- Determine the relevance and reliability of financial statements prepared using historical cost accounting in representing the financial performance and financial position of a company.
- Investigate the feasibility and practicality of adopting current cost accounting as an alternative reporting method.
CHAPTER TWO
REVIEWED OF RELATED LITERATURE
Historical Cost Accounting
Fair Value Accounting
The following is the absolute content of the International Financial Reporting Standard 13 -Fair Value Management – IFRS 13, Fair value management’, provides a common framework for measuring fair value where required or permitted by another IFRS.IFRS 13 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The key principle is that fair value is the exit price, from the perspective of market participants who hold the asset or owe the liability, at the measurement date. It is based on the perspective of market participants rather than the entity itself, so fair value is not affected by an entity’s intentions towards the asset, liability or equity item that is being fair valued. A fair value measurement requires management to determine four things: the particular asset or liability that is the subject of the measurement (consistent with its unit of account); the highest and best use for anon-financial asset; the principal (or, in its absence, the most advantageous) market; and the valuation technique. IFRS 13 addresses how to measure fair value, but it does not stipulate when fair value can or should be used. Sourced from (http://www.pwc.com.ifrs-19) The first definition is inappropriate in determining the fair value of an asset or liability. As a result, the FASB and IASB have agreed on a modified method to determine fair value. Instead of basing market price on an exit price, the new rules allow companies to look for the most advantageous market for an asset or liability when assigning it a fair market value. Determining the true market value of an asset is sometimes controversial, especially for assets that do not have active and liquid markets. By definition, the fair value does not need the existence of an active market. In case of market inexistence, IASB offers guideline that looks at the type of assets or liabilities. For instance, for property, plant and equipment, depreciated replacement cost is recommended if market based evidence is unascertainable. For biological assets (animals and plants), IASB suggest the use of discounted present values of future cash flows (Weetman, 2011). Later, FASB introduced FASB ASC 820 – Fair Value Measurements and Disclosures (SFAS 157) (Zyla, 2010). The main aim of this statement is to offer additional guidance and information on issues that relate to fair value and its measurement. FASB ASC 820 – Fair Value Measurements, in technical terms, does not bring in any new accounting principle rather it provides financial analysts and auditors with additional information on how the FASB intends fair value to be measure in any instance it is required in financial reporting (Zyla, 2010). The FAS 159 – the Fair Value Option (FVO) on Financial Assets and Financial Liabilitiesbrings in the fair value option that a company may use in their first and successive measurements of their particular financial liabilities and assets on contract basis (American Academy of Actuaries Life Financial Reporting Committee [AAALFRC], 2009).
CHAPTER THREE
RESEARCH METHODOLOGY
INTRODUCTION
In this chapter, we described the research procedure for this study. A research methodology is a research process adopted or employed to systematically and scientifically present the results of a study to the research audience viz. a vis, the study beneficiaries.
RESEARCH DESIGN
Research designs are perceived to be an overall strategy adopted by the researcher whereby different components of the study are integrated in a logical manner to effectively address a research problem. In this study, the researcher employed the survey research design. This is due to the nature of the study whereby the opinion and views of people are sampled. According to Singleton & Straits, (2009), Survey research can use quantitative research strategies (e.g., using questionnaires with numerically rated items), qualitative research strategies (e.g., using open-ended questions), or both strategies (i.e., mixed methods). As it is often used to describe and explore human behaviour, surveys are therefore frequently used in social and psychological research.
CHAPTER FOUR
DATA PRESENTATION AND ANALYSIS
INTRODUCTION
This chapter presents the analysis of data derived through the questionnaire and key informant interview administered on the respondents in the study area. The analysis and interpretation were derived from the findings of the study. The data analysis depicts the simple frequency and percentage of the respondents as well as interpretation of the information gathered. A total of eighty (80) questionnaires were administered to respondents of which only seventy-seven (77) were returned and validated. This was due to irregular, incomplete and inappropriate responses to some questionnaire. For this study a total of 77 was validated for the analysis.
CHAPTER FIVE
SUMMARY, CONCLUSION AND RECOMMENDATION
Introduction
It is important to ascertain that the objective of this study was to ascertain the effect of historical cost accounting on the reported profit of a company: an evaluation of current cost accounting as an alternative reporting method. In the preceding chapter, the relevant data collected for this study were presented, critically analyzed and appropriate interpretation given. In this chapter, certain recommendations made which in the opinion of the researcher will be of benefits in addressing ascertain the effect of historical cost accounting on the reported profit of a company: an evaluation of current cost accounting as an alternative reporting method Summary
This study was on ascertain the effect of historical cost accounting on the reported profit of a company: an evaluation of current cost accounting as an alternative reporting method. Three objectives were raised which included: Analyze the extent to which historical cost accounting affects the reported profit of a company by comparing financial statements prepared using this method with those adjusted to reflect current market values of assets, determine the relevance and reliability of financial statements prepared using historical cost accounting in representing the financial performance and financial position of a company and Investigate the feasibility and practicality of adopting current cost accounting as an alternative reporting method. A total of 77 responses were received and validated from the enrolled participants where all respondents were drawn from selected accounting firms in Lagos. Hypothesis was tested using Chi-Square statistical tool (SPSS).
Conclusion
In conclusion, while historical cost accounting remains prevalent in financial reporting, its limitations in reflecting changes in asset values over time have prompted calls for alternative approaches such as current cost accounting. While current cost accounting offers the potential for more accurate and relevant financial reporting, its adoption requires careful consideration of practical challenges and implementation issues.
Moving forward, efforts to enhance financial reporting practices should focus on promoting transparency, relevance, and reliability in financial statements. This may involve exploring hybrid approaches that combine elements of historical cost accounting and current cost accounting to provide a more comprehensive view of a company’s financial performance and financial position.
Overall, this study underscores the importance of critically evaluating accounting methods and their implications for reported profits, decision-making, and stakeholder perceptions. By addressing the limitations of historical cost accounting and exploring alternative reporting methods, stakeholders can make more informed decisions and foster greater trust and confidence in financial reporting processes and outcomes.
Recommendation
- Given the limitations of both historical cost accounting and current cost accounting, companies should consider adopting hybrid approaches that incorporate elements of both methods. This could involve valuing certain assets at historical cost while adjusting others to reflect their current market values. By leveraging the strengths of each approach, companies can provide a more comprehensive and balanced view of their financial position and performance.
- Companies should enhance their disclosure practices to provide stakeholders with transparent and comprehensive information regarding the accounting methods used and the rationale behind their choice. This includes disclosing the impact of different accounting methods on reported profits and the potential implications for decision-making. Enhanced disclosure can promote transparency, build trust, and facilitate informed decision-making among stakeholders.
- To facilitate the adoption of current cost accounting, companies should invest in robust market data infrastructure to obtain reliable and up-to-date market prices for assets and liabilities. This may involve leveraging technology solutions, collaborating with industry partners, or engaging third-party data providers to ensure access to accurate and timely market data. By investing in market data infrastructure, companies can improve the accuracy and reliability of current cost accounting adjustments.
- Accounting professionals should receive enhanced education and training on alternative accounting methods, including current cost accounting. This will equip them with the knowledge and skills needed to effectively implement and apply alternative accounting methods in practice. Professional organizations, academic institutions, and industry associations can play a role in developing and delivering training programs that address the complexities of alternative accounting methods and their practical implications.
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