Failure to disclose the current worth of the enterprise

The accounts presented using historical cost accounting do not show many

effects that are due to the inflation gap. Thus, a true and fair view is not
given.

2. Incomparable items in financial statements

Sometimes, due to inflation, certain items in financial statements show a

higher value, but this does not necessarily mean that the enterprise is making
progress.

For example, sales for three years may be $20,000, $80,000, and $38,000. In

this case, the company's higher sales figures are attributable to inflation and
not to an increase in sales.

When these sales are converted on the common index number, then the
result is that the sales are the same as they were before.

3. Difficult to replace fixed assets

Under the historical cost concept, depreciation is charged on the

original cost.

Under inflation, the cost of fixed assets increases, and so the rate of
depreciation is not sufficient to replace fixed assets.

4. Inaccurate determination of profit

Historical cost accounting does not disclose the correct profit or loss in an
inflationary situation.

Under inflation, more profit is always shown due to over-valuation of closing

stock.
In such cases, the income tax burden increases and employees may demand
higher salaries and more perks.

The distribution of profits in the form of dividends does not add to the

general reserves.

5. Mixing up of holding and operating profits

Historical cost accounting does not disclose the effect of closing stock on
profit.

Therefore, profit due to the overvaluation of inventories is mixed up with

business profits, and does not show the correct profitability.

Measurement errors may have reduced the usefulness of current-cost and replacement-
cost data. Replacement-cost valuations of plant and equipment often include the cost of
technological advances and often these advances would reduce operating costs below
the level reported by historical cost. As a result, when replacement-cost depreciation is
substituted for historical-cost depreciation, the cost of doing business includes the high
capital cost of the advanced technology as well as the high operating costs of the older
technology in use, which creates measurement errors.

The supporters of Historical Cost Accounting criticize  Current Cost Accounting because
it violates the traditional revenue recognition principle by recognizing increases in the
value of the assets, both current and non-current, before they are sold. This is irrelevant
as changes in market price don’t mean anything until the assets are sold. A non-current
asset isn’t more valuable to a business just because its current cost has increased.

Another problem is the subjectivity of determining the amount of the increase in cost.
There are some non-current assets that don’t have a second-hand market because it
was specifically built or made for that business only. So the basis of determining the
current cost must be the new asset expected to replace the old one.