The Historical Cost Convention Essay
The Historical Cost Convention
The historical cost convention used in historical cost accounting, records transaction at the monetary value at the date of transaction (i.e. their historical cost). An asset or liability being measured using the historical cost basis is recognized initially at transaction cost. This convention is used as a basis to prepare financial statements. In the income statement, revenues and expenses are recorded at the monetary value shown on the invoice. Historical cost accounting (HCA) might be the most suitable convention for stewardship purposes but may not be the most suitable for decision usefulness. This view has been apparent in the UK, with attempts to introduce supplementary accounts based on the current purchasing power (CPP) convention and the current cost convention (CCA). Neither of these alternatives was adopted after their initial trial.
The HCA depends on depreciation policy and inventory valuation therefore it is subjective. Such a characterization tends to assume, however, that all historical cost measures are transaction-based and involve little estimation, which is not the case. For example, adjustments made to the historical cost carrying value of trade receivables to make allowance for bad and doubtful debts involve a degree of estimation that is not dissimilar to that involved in estimating current values not derived from an active market. And the results are often of broadly similar reliability. There is a similar level of estimation involved in determining the cost of self-generated assets and by-products, and generally in all circumstances involving allocations of substantial amounts of indirect costs.