historical-cost accounting

historical-cost accounting A system of accounting based on the principle that assets should be valued at historical cost. It is relaxed to some extent by such practices as the valuation of stock at the lower of cost and net realizable value and, in the UK, revaluation of fixed assets. The advantages of historical-cost accounting are that it is relatively objective, easy to apply, difficult to falsely manipulate, and suitable for audit verification. In times of high inflation, however, the results of historical-cost accounting can be misleading as profit can be overstated, assets understated in terms of current values, and capital maintenance is only concerned with the nominal amount of the capital invested rather than its purchasing power. Because of these defects it is argued that historical-cost accounting is of little use for decision making, but attempts to replace it with such other methods as current-cost accounting have failed.

Company legislation sets out the rules for the application of historical-cost accounting to financial statements. Companies may also choose to use alternative accounting rules based on the modified historical-cost convention, in which certain assets are included at revalued amounts.