Accounting Methods Explained – Assignment Example

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Accounting Methods Explained – Assignment Example

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Introduction The primary objective of the assignment is to determine the drawbacks of historical cost accounting.

In addition, the advantages and disadvantages of current cost accounting, exit price accounting, current purchase power accounting, and continuously contemporary accounting are discussed.

In the end, the best option and accounting field are outlined and recommended based on this discussion as well as the conclusion.

All in all, the underlying assignment gave students a chance to learn about various accounting fields and choose and recommend the best field.

The limitations of historical cost accounting include the fact that all financial items and transactions are recorded based on their original cost, making it one of the most widely used accounting methods in recent years.

More specifically, according to historical cost accounting (Zack 2009), a company should record all financial transactions using the original cost rather than the market value.

If a company records financial transactions using the market value rather than the original cost, this is considered unfair.

This idea is based on the assumption that the actual money paid or received by the company during a financial transaction should be recorded and entered into books.

Historical cost accounting is therefore being criticized for a variety of reasons.

The following are some of the drawbacks of historical cost accounting:
1) Improper when prices are shifting and rising Experts in accounting argued that historical cost accounting cannot be utilized when prices are shifting and fluctuating.

According to some, historical cost accounting doesn’t take into account market value, so it doesn’t give a true picture of financial transactions.

For instance, based on historical costs, an asset ought to be recorded in the books at its acquisition cost.

The fact that an asset’s price and value fluctuate over time is completely ignored. In the not-too-distant future, an asset purchased in the past may become more or less affordable.

To put it another way, the asset always has a time value, and this fact can’t be ignored if you want to accurately evaluate financial transactions.

When comparing corporate performance, the significance of time value grows because it has the power to alter the value of both assets and transactions (Delaney & Whittington, 2010).
2) Capital maintenance perspective According to the capital maintenance perspective, historical cost accounting is also inappropriate.

From the perspective of the phenomenon of capital maintenance, a company is considered to have made a profit only when its net assets grow in size and value at the end of the period.

To put it another way, the value of assets is measured and compared at the beginning and end of the period to see if the business has benefited from the acquisition of assets.
Due to the fact that the value of assets at the time of purchase and disposal will vary significantly, historical cost accounting cannot be used for this purpose.

This is clear because assets are bought at their original cost and recorded in the books, whereas assets are sold at market prices, which are not taken into account by historical cost accounting.

This accounting method makes it impossible to accurately calculate and determine the actual contribution and gains resulting from asset transactions.
3) Operating results that are distorted Historical cost is also criticized for operating results that are distorted.

It is sometimes argued that the operating result is exaggerated and overstated by historical costs.

The fact that historical cost accounting ignores price changes is the root cause of this limitation.

Since historical cost accounting is said to ignore changing prices, it is possible that profit figures are exaggerated and shareholders receive an inaccurate picture of the organization’s operational performance.

Gains and losses are only recorded in the books under historical cost accounting when they are actually received.
To put it another way, the particular accounting system does not take into account the idea of accrued gain and loss (Schroeder, 2011).

For instance, if some assets were purchased in the past at a very low price with the intention of selling them at a high price in the future, historical cost accounting will only enter profit and loss on assets when the assets are ultimately sold.

This method of accounting distorts operating results for both previous and subsequent periods because it places all gains from previous years in the subsequent periods.

Flexible prices that fit everyone’s budget Current cost accounting: Benefits and Drawbacks This method of accounting takes into account the current replacement cost of assets, as the name suggests.

The current method of cost accounting does not take into account the initial price paid for assets.

In this context, the most obvious benefit of this accounting method is that it can be used when prices change.

More specifically, the assets’ current market value is taken into account when adjusting their valuation.

The time-value of the assets is taken into account and given a lot of weight by the current cost accounting (Ahmad, 2012).
Assets should be recorded at market prices in order to have an accurate assessment and picture of financial transactions because it is believed and accepted that assets’ value can increase or decrease over time.

Because every transaction and entry is recorded on the basis of realised value, current cost accounting also provides the advantage of having an accurate idea of the corporate performances.
On the other hand, there are a number of drawbacks to current cost accounting as well.

For instance, the volatility of the market price of assets frequently results in assets being over or underestimated.

Financial data may become unrealistic and unreliable as a result of market price volatility.

Due to market price fluctuation and volatility, investors and shareholders find it difficult to make a decision.

It has been observed numerous times that investors and shareholders develop a kind of fear and resistance attitude regarding their return and probable earnings in response to changing and volatile market prices.

In this context, it is frequently challenging for businesses to win over shareholders and investors.

Accounting for exit prices: Benefits and Drawbacks Exit price accounting is a novel accounting method that takes into account a company’s decision to leave a particular industry.

This is obvious because concerns about assets arise whenever a company decides to leave or exit the industry.

According to Walton & Aerts (2006), every business enterprise possesses a specific set of assets that must be appropriately dealt with upon exit.

By providing a method of accounting for determining the value of assets, exit price accounting serves and facilitates this task.

Exit price accounting stipulates that assets should be sold at the net selling price shown on the balance sheet at the time and date of the business firm’s exit.
When it comes to providing users—investors and shareholders—with information, exit price accounting is regarded as the more trustworthy and pertinent option.

This is because investors and shareholders are interested in asset values that are genuine, dependable, and pertinent.

It can also be understood that businesses are required to evaluate their current and non-current assets when exiting or leaving the industry.
This assessment is done to settle creditors’ claims, figure out the return or earnings available to shareholders, and figure out business firms’ liabilities.

In order to plan and carry out the exit decision in an efficient and effective manner, it is equally essential to obtain an accurate and real assessment of both current and non-current assets.

By providing investors, shareholders, and creditors with a true and dependable estimate of the value of their investments and assets, exit price accounting can accomplish this goal by satisfying all of these stakeholders.
Exemplifying the significance of exit price accounting is helpful in making the point.

Similar to depreciation, the market price of both current and non-current assets decreases.

When assets’ prices and values rise or when the value of non-current assets does not change, exit price accounting does not account for depreciation (Dutta). 2010).
The exit price accounting, on the other hand, comes with a few drawbacks as well.

The approach and scope of exit price accounting, according to proponents of historical cost accounting and current cost accounting, are too brief and restricted.

It is stated that all assets and items on the balance sheet are evaluated based on exit prices, or market prices at the time.

There is a possibility that the firm’s decision to exit the industry was based on exit prices that were too low, undervaluing the assets and other items on the balance sheet.
The main criticism of exit price accounting is that it places more emphasis on price fluctuations than on whether or not business operations are carried out effectively.

To put it another way, experts assert that a company’s performance is also influenced by the efficiency with which its operations are carried out (Debarshi, 2009).

The exit price accounting disregards this fact and places sole emphasis on the assets’ financial value at the time of exit.

The fact that the firm’s operating efficiency cannot be tested solely with the financial value of assets, as there are numerous instances in which the firm’s operating efficiency is high but the financial value of assets is high, and vice versa.

This means that the financial value of assets is not the only criterion for evaluating a company’s performance.

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Current purchase power accounting: Benefits and Drawbacks The current purchase power accounting system is regarded as a revolutionary and innovative accounting innovation.

The main purpose of this accounting method is to fix problems with historical cost accounting.

For the purpose of converting and transforming the value of profit and loss items and the balance sheet into present value, an approved general price index is chosen.

In other words, the current purchasing power accounting method uses an approved price index to convert all items recorded using historical cost accounting into present value.

This is accomplished by preparing a supplemental financial statement that reflects the current market value of each historical item.

Retail price index or wholesale price index can be the approved price index that is typically used for converting and transforming historical items based on their current market value.
The fact that price change factor is taken into account is the most obvious benefit of current purchase power accounting.

The fact that the historical account and financial statements are also kept and maintained are two additional benefits of this accounting method.

To put it another way, businesses benefit from having both old and new financial statements (Whittington, 2003).

However, one of the drawbacks of current purchase power accounting is that it can be challenging to select an appropriate general price index.

When converting historical financial assets to market prices, businesses frequently struggle to select the appropriate price index.

Second, it is argued that it takes a lot of time and effort to convert historically recorded financial transactions into their current market value.

Accounting that is always current: Benefits and Drawbacks This accounting method assumes that a company’s economic and financial environment are constantly shifting.

The valuation of financial transactions and goods, for instance, is affected simultaneously by inflation, changes in exchange rates, variations in price levels, and technological advancements. The underlying accounting method uses the changing purchasing power of money to calculate and determine the value of assets.
This accounting method simply uses the current cash price to calculate and value assets and items on the balance sheet.

For instance, the asset’s net realisable value if sold now, given the current market and environment.

The primary goal of modern accounting is to assist businesses in making decisions that are both feasible and practical.

It is evident that business organizations are aware of and knowledgeable about the current case price of assets, which undoubtedly aids in making the best decision.

According to Nobes (2007), continuously modern accounting prompts businesses to determine and calculate predicative selling prices for assets in order to determine and arrive at profit figures that the businesses are likely to earn as a result of selling those assets on the market.
One of the advantages of the continuously modern accounting method is that it is simpler to adopt and easier to use in balance sheets and financial statements.

It is said that this method of accounting always informs managers and other strategic employees of a company about predicted asset purchasing and selling prices.

A business can make the most of emerging market opportunities and business trends by being aware of and knowledgeable about predictive selling prices, which enables the business to arrive at the most feasible and practical decision. Since it evaluates assets based on the current cash price, continuously contemporary accounting’s estimates and calculated figures are also regarded as more accurate and realistic by shareholders.
However, there are a number of limitations and drawbacks associated with adopting and implementing continuously modern accounting.

The first set of restrictions has to do with how accounting practices need to change.

In more detail, the majority of business firms’ accounting practices are cost-based, which means that assets and financial transactions are entered and recorded based on the cost of their purchase.

To put it another way, when a business prepares its financial statements, it frequently disregards the current cash price. In this context, businesses must calculate the current cash price of all assets in order to implement this accounting method, which requires more time and resources.

Are you overwhelmed by a lot of homework and feeling stressed? Take Advantage of Expert Academic Support to Receive Zero Plagiarism Papers Conclusion and Recommendation Based on the aforementioned discussion, it is possible to assert that each accounting method has its own significance and implication.

There is a method of accounting that can be used in a variety of situations and environments.

Current purchasing power accounting is the best option and alternative for businesses, according to recommendations.

There are a number of reasons to consider it the best choice and alternative.
First, it will provide the company with knowledge, awareness, and access to both historical and current market prices.

Second, having both main and supplementary financial statements allows businesses to easily compare historical and current market prices.

According to Greuning & Koen (2001), the market prices of assets will be included in the supplementary financial statement, whereas the originally recorded historical prices will be included in the main financial statement.
Businesses can easily compare, evaluate, and make the best decision possible on this basis.

In addition, the efficiency with which managerial authorities make decisions is enhanced by this accounting method.

This is due to the fact that managers and authorities are able to easily compare the historical and current market prices of assets and items on the balance sheet, allowing them to create appropriate financial plans and policies.