Historical costs represent the value of an asset at the time when the company acquired it. In other words, the historical cost represents the original price of an asset stated in the trade documents. The relevance of historical approach in accounting is debatable because all assets are subjected to cost adjustments, and the original value of assets depreciates with time. On the other hand, the presence of historical cost data brings the necessary objectivity into accounting. Exploring the opposing points of view on the topic and defining the advantages and disadvantages of using historical cost, can explain why the FASB has chosen to depart from using this approach.
Firstly, the reason experts suggest departing from historical costs is that balance sheets record both historical cost and their depreciation. While organizations are required to feature historical costs in balance sheets, it is obvious that the net value of an organization’s assets is subjected to several changes. Thus, historical costs in balance sheets can be misleading to members of third parties. Furthermore, stakeholders are unlikely to use information from historical costs because they are primarily interested in the fair value of the company’s assets. Therefore, the arguments in defense of the rejection of historical costs reflect the interests of stakeholders interested in up-to-date information about the company.
On the contrary, the use of historical costs in balance sheets prevents organizations from providing subjective data in balance sheets. For example, featuring the potential sale price of assets can significantly distort information for potential investors (Hsu & Wu, 2018). Furthermore, tracking the asset’s price dynamics by comparing the historical cost with depreciation expense data can provide additional information about the company and its financial potential to potential creditors and investors. Thus, the arguments in defense of the use of historical prices protect the interests of creditors who make decisions about providing funding to the company.
Furthermore, the combination of existing information about historical costs can be used to create a list of its advantages and disadvantages. Firstly, the historical cost data is comparable with the results of the company’s activity and can provide an additional source of information for potential stakeholders. Next, the historical cost data is supported by external documents, which confirms its reliability for use in balance sheets (Tkachuk, 2019). Furthermore, in combination with depreciation expenses, the historical cost can serve as a basis for monitoring the company’s management of assets. On the other hand, the historical cost data loses its relevance in reflecting the actual state of the company’s financial resources over time. Moreover, the combination of various historical cost statements on assets purchased at different times can introduce significant misunderstandings about the company’s current position in the market.
Comparing the advantages and disadvantages of the use of the historical cost concept in accounting determined that the historical data is irrelevant for displaying the current state and activities of a company. Recently, FASB has been making attempts to depart from historical cost to fair market value in many of its accounting standards. Fair value is based on the hypothetical price of sale at the measurement date, which favors a more accurate representation of the company’s current state. Thus, even though historical data is objective and more reliable in comparison with fair market value, accounting should prioritize displaying important and relevant information for all stakeholders, including external users.
References
Hsu, A. W., & Wu, G. H. (2018). The fair value of investment property and stock price crash risk. Asia-Pacific Journal of Accounting & Economics, 26(1), 38-63. Web.
Tkachuk, N. V. (2019). Historical cost and fair value: Advantages, disadvantages, application. Journal of History Culture and Art Research, 8(1), 173-182. Web.