ACCOUNTING MYTHS, No. 3 Historical cost

Press, 29 February 1984, Page 30

ACCOUNTING MYTHS, No. 3 Historical cost

By

Alan J. Robb

It is commonly thought that conventional accounts are prepared on the basis of historical cost. Until it was revised, Statement of Standard Accounting Practice No. 1 stated that “in the past the majority of companies have followed the historical cost basis.” In the revised standard issued in December, 1983, the wording has been altered significantly to read, “measurement bases normally used are historical cost, historical cost adjusted for the revaluation of certain assets and current cost.” It is unfortunate that the statement still continues to perpetuate the myth that pure historical cost is normally used. It is more accurate to say that the measurement base normally used is historical cost adjusted for the revaluation of certain assets, but even then how much ' historical cost appears in a balance sheet? . When one considers it cash is probably the only asset which is not subject to any revaluation. Consider the other assets — accounts receivable (or debtors) are adjusted to allow for doubtful debts. This adjustment is a revaluation designed to bring them closer to their estimated cash equivalent — a frequent and clear instance of the abandonment of historical cost.

Next there is inventory. It is normally valued at the lower of cost and net realisable value. Accountants are usually unwilling to revalue inventory above cost but have no qualms about abandoning historical cost to revalue it downwards.

investments are valued in several different ways. Shares in associated companies may be revalued upwards or downwards according to the profits or

losses made by the associate company. Such revaluations in no way represent additional costs to the investing company. Other shares are frequently revalued in either direction as market prices rise or fall and ff not revalued then market values of listed investments are required to be stated by way of note. The recent exposure draft on accounting for investment properties proposes that such assets be included on the balance sheet at their market values and that they be revalued annually. For a number of years many companies have been revaluing land and buildings as and when new Government valuations have been received. There have also been defensive revaluations when a company has been faced with an unwelcome takeover. This was seen in 1980 when Lane Walker Rudkin faced a raid by Brierley Investments. LWR reported a 42 per cent revaluation of land and buildings. One would be hard pressed to find a major company which does not revalue its property periodically. While some revalue to only 80 or 90 per cent of Government valuation in the name of conservatism others are likely to follow the example of Fletcher Challenge, which now revalues its land and buildings annually to estimated market value each balance date. The accounting profession in New Zealand has acknowledged that companies are free to adopt bases other than historical cost in their accounts. In its original form SSAP 1, Disclosure of Accounting Policies, explicitly stated that it did not in any way restrict a company wishing to use a basis other than historical cost. The revised SSAP is now

less explicit but still permits bases such as market value. Indeed, the Society of Accountants has explicitly advocated annual revaluations to market prices. In its booklet on accounting for clubs issued in 1974 it is stated that assets should be revalued. This applied to all assets and not simply those given or required at very little cost. Similarly, research bulletin R 404, “Management Accounting for the New Zealand Farmer,” and the exposure draft of technical practice aid No. 5, “Valuation of Livestock in the Financial Statements of Farming Enterprises,” both advocate using net current market values on the grounds that this is the most realistic and useful information for users. What are the implications of this? First, it is clear that the old notion that a balance sheet is a historical document only and does not purport to show realisable values is invalid. A balance sheet is becoming a statement of market values. For companies such as Fletcher Challenge and Aurora which revalue assets annually the balance sheet is properly a statement of financial position as that term is commonly understood. Second, if a business values all its assets at market values we may see the demise of the concept of the “going concern.” This concept deserves an article to itself but for the present it is sufficient to say that it has been used by accountants largely as a justification for retaining historical cost valuation for fixed assets. For instance one standard text says this assumption . . . underlies the practice of stating fixed assets at a figure based on cost less a provision for depreciation.