Principles of Financial Accounting

Principles of Financial Accounting
Principles of Financial Accounting

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Principles of Financial Accounting

Major accounting concepts and conventions used in accountancy form the major guidelines and rules of the accountant’s life. Historical cost accounting convention is a technique in accounts that ensures valuation of an existing benefit for the balance sheet at the cost of the asset at its purchase.

Assets, revenue, and expenditures are recorded at the money’s worth that was historically paid to complete the transaction (Deegan 2013). All the items in the financial statements are recorded at what cost the company for an item and not the fair market value and not what the company could currently sell the item.

The major criticism of historical cost is that it considers the cost of acquisition despite this cost of an asset not recognizing the current market value. It only interests itself in the cost allocated and not in an asset’s value. It tells the acquisition value and decrease in succeeding years but ignores the likelihood of the present market worth of the asset being elevated or lower than its suggestion (Miles 2015).

Historical costs also exhibit an obvious fault during times of inflation. Its validity rests on an assumption that currencies for recording the transactions remain stable or stagnation of the purchasing power. During inflation, the price of an asset rises, however, the corporate finance model’s objective centers on creating value for shareholders.

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The main advantage of historical cost is that the accounts are straightforward in producing them. The original value of the asset is known and recorded thus based on an actual value and not an estimation of value. Historical costs do not also record gains to the company until full realization is realized thus, presenting the actual performance of a company. Historical cost accounts further are still utilized under many accounting systems such as the GAAP that requires the value of an asset recorded at its historical costs with an exception of marketable securities (DRURY 2013).

The alternative methods or bases introduced by IASB is the Capital Maintenance in Units of Constant Purchasing Power, that allows for the quantification of financial assets maintenance in ostensible monetary units or in units of purchasing control that can be constant regardless of deflation or inflation levels (Kaplan et al., 2015). The major advantage of this technique is that it allows the management to make a judgment when applying or developing an accounting policy when there is an absence of interpretation applying to a transaction.

The major disadvantage of this system is that it provides no applicable international standard for financial reporting with regards to the assessment of invariable but real value items that are non-monetary. These may include share capital that has been issued and capital reserved. It is also not chosen by accountants in non-hyperinflationary economies despite its automatic maintenance of the actual worth of non-monetary items with steady genuine value (Van Dooren et al., 2015).

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An analysis of the qualitative analysis indicates that historical cost accounts are easily understood because it is based on original costs. The values are relevant because it is a true representation. The values can however not be reliable on the verge of hard economic times.

However, comparability is possible depending on the underlying assumptions and the judgment of the management. Alternative bases by IASB are relevant because they represent the current economic conditions (DeVellis 2012). They are easy to understand and compare the figures hence, reliable as a tool for financial reporting.

Historical cost is the most appropriate basis for measurement in financial reporting. The underlying factor here is that it is free of any bias information and is follows the GAAP procedures. It is also simple and a more conventional method and helps in leading to absolute certainty by fitting perfectly with the statement of cash flow.


Deegan, C. (2013). Financial accounting theory. McGraw-Hill Education Australia.

Miles, L. D. (2015). Techniques of value analysis and engineering. Miles Value Foundation.

DRURY, C. M. (2013). Management and cost accounting. Springer.

Kaplan, R. S., & Atkinson, A. A. (2015). Advanced management accounting. PHI Learning.

Van Dooren, W., Bouckaert, G., & Halligan, J. (2015). Performance management in the public sector. Routledge. DeVellis, R. F. (2012). Scale development: Theory and applications (Vol. 26). Sage publications

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