Historical Cost Accounting

Historical cost accounting provides three key advantages. First, it is free of bias. Second, less labor is required to complete a financial statement using historical cost accounting than fair value accounting. Third, it can be legally verified through invoices and contracts.

Historical cost accounting does not permit bias. Under historical cost accounting, the price paid for a product remains on the ledger as “product cost”. Under fair value accounting, an appraiser can be used to determine the price of a product while a company still possesses that product. An appraiser can intentionally or unintentionally be biased because price estimation is subjective. For instance, in a personal conversation with Justin Henry, an accountant, I learned of a situation in which three appraisers examined the same house within a few weeks of each other. Each appraiser estimated a price for the house that was $5,000 different from each of the other appraisers (J. Henry, personal communication, March 3, 2020).

Developing financial statements under historical cost accounting requires less work. According to bankrate.com, “A typical, single-family home appraisal will range from $300 to $450” (Chang, 2019). According to Mr. Henry, the new market price of a stock needs to be accounted for in financial statements each quarter under fair value accounting. Under historical cost accounting, a change in the market price of a stock does not prompt accountants to adjust financial statements each quarter (J. Henry, personal communication, March 3, 2020).

Historical cost accounting is legally verifiable because it is based on invoices and contracts. If a discrepancy occurs, both parties can return to an invoice to verify the purchase price. Invoices and contracts are documents that cannot be edited once finalized. It is a benefit to a business that, under historical cost accounting, the price of an asset currently on their books cannot vary depending on the condition of that asset’s market. The president of Elliot and Company Appraisers, Charles Elliot, stated that an acceptable appraisal variance for a housing market in good condition is “within two or three percent of other appraised values. In others [other situations] where market conditions are challenging and hard to predict, a 10 percent variance is welcomed” (Elliot, 2011).

Historical cost accounting helps corporations avoid the costs and risks associated with price estimation. This accounting method is objective, labor efficient, and legally dependable. These benefits help accountants efficiently and accurately prepare financial statements.

References

Chang, E. (2019, November 6). How Much Does A Home Appraisal Cost? Retrieved March 30, 2020, from https://www.bankrate.com/mortgages/how-much-does-an-appraisal-cost/

Elliot, C. W. (2011, September 6). How Accurate Are Real Estate Appraisals? Retrieved March 30, 2020, from https://nationalmortgageprofessional.com/news/22176/how-accurate-are-real-estate-appraisals