Inadequacies of Traditional Historic Cost Accounting Methods in Times of Changing Price Levels - Essay Example

Based on the traditional historic cost accounting method, the financial accounting of any business is done considering the earnings and costs that are associated only with the internals 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 consideration that have some effect 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, the 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 because the accountants used to measure transactions related to finance in terms of the 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 in time (Gupta 2004). The change in price levels reflects that when there is a price rise, 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 price changes thus requiring new accounting techniques for businesses (Dutta 2003). The major problem with traditional historic cost accounting regarding changing price levels is that it depends significantly on the 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, the life cycles of the 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 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 one of the steps in 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 execution costs allow the organization to realize the post-design costs (Adler 2013).