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Inadequacies of the traditional historic cost accounting method in times of changing price levels and the alternative methods - Essay Example

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Title: Inadequacies of Traditional Historic Cost Accounting Method in Times of Changing Price Levels and Alternative Methods Introduction: Accounting and financial calculations using traditional historic cost accounting are based on changes in the market, considering the market news and conditions to be unbiased and objective in nature…
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Inadequacies of the traditional historic cost accounting method in times of changing price levels and the alternative methods
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Download file to see previous pages Inadequacies of Traditional Historic Cost Accounting: Based on the traditional historic cost accounting method, financial accounting of any business is done considering the earnings and costs that are associated only with the internal of the organization. Decisions are taken based on such measures that exclude economic transactional information without having any market value. With this technique only those external financial factors are taken into considerations that have some effects on the overall financial outcome of the business. Thus other social, economic or environmental factors are not considered in this method of accounting (Bailey, Harte and Sugden 2002). For any business organization, accounting method needs to realize the changes in prices in the market and be feasible in the process of accounting accordingly. The inadequacies with the traditional historic cost accounting method arise since the accountants used to measure transactions related to finance in terms of monetary unit. The method proved to be unstable as the monetary value keeps changing with conditions in the market. With changes in the value of the rupee or dollar or any other unit, financial statements would reflect distorted amounts. For example if acquisition costs of assets are added to the statements, it does not prove to be rational since the value of the monetary unit is different at different points of time (Gupta 2004). The change in price levels reflects that when there is a rise in price, there is an increase in the prices of all items. The value of assets during these times may also increase, but the rates of increase may not be the same for all items. Thus general price rise and specific price rise are two forms of rise in prices requiring inflation accounting methods for business organizations to achieve accurate financial accounting. The historic cost accounting proved to be adequate to measure these prices changes thus requiring new accounting techniques for businesses (Dutta 2003). The major problem with the traditional historic cost accounting in regard to changing price levels is that it depends significantly on volume of output that an organization achieves. The categorization of costs may be done into four classes – variable, fixed, step fixed, and mixed – that may prove to be inappropriate. Considering the present day business performances, life cycles of product are short and there are higher levels of automation. This makes the above mentioned classification of costs less relevant for the organization and leads to satisfaction of the team simply counting on the costs and not managing them well (Adler 2013). Alternative Methods: With the problems and inaccuracies of the traditional cost accounting method proving to be inadequate for the present day business financial accounting, management teams had to plan for alternatives to replace the historic cost accounting method. Focus on strategic cost drivers has been considered as one of the steps of measuring costs effectively. This process allows an organization to divide its costs into structural and executional costs. While the structural costs allow the measurements of the costs related to the designs of the organization, the executional costs allow the organization to realize the post-design costs (Adler 2013). Alternatives to the historic cost ...Download file to see next pagesRead More
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