Definition
The financial accounting term current cost accounting refers to an approach that values assets at their fair market value rather than historical cost. In practice, current costs can be determined in a number of ways, including applying a specific price index to the book value of the asset.
Explanation
Recording and reporting transactions at historical costs is one of the long-standing principles of the accounting profession. However, this approach is not without its critics, especially when an economy experiences double-digit inflation or process improvements result in a relatively rapid decrease in prices. A number of alternative approaches to the reporting of financial statements have been proposed, including current cost accounting.
Also known as the specific price-level method, current dollar accounting uses a specific index of prices to reflect the current value of certain assets and liabilities held by a company. Proponents of the approach believe this method allows for more accurate reporting of the company's financial position. It also brings the Financial Accounting Standards Board's Generally Accepted Accounting Principles into better alignment with that of the International Accounting Standards Committee.
The objective of the current cost accounting method is to report the financial assets and liabilities of a company at their fair market value rather than historical cost. For example, the book value of the vehicles owned by a company may be $15,000,000; however, the fair market value of the vehicles might be closer to $8,000,000. This approach is similar to those accounting requirements that apply to certain classes of investments owned by companies such as marketable securities held for trading purposes.
In practice, it would be impracticable to determine the fair market value of all the assets and liabilities held by a corporation. Critics of the approach believe investor-analysts would have trouble determining which values are based on historical cost versus their replacement cost. In addition, when assets and liabilities are recorded on the balance sheet at their fair market values, any change in value typically flows to the income statement. Once again, critics of the approach believe this will lead to distortions in the perceived profitability of a company.
Related Terms
The financial accounting term Historical Cost Principle refers to a valuation technique used in the preparation of financial statements. The Historical Cost Principle states the value of an asset or liability is recorded on the balance sheet at its cost at the time of acquisition.
Moneyzine EditorJanuary 19th, 2024
The financial accounting term constant dollar accounting refers to the conversion and reporting of historical financial information in current dollars. The constant dollar accounting method requires the conversion of certain historical assets and liabilities to current dollars using a generally accepted measure of inflation such as the Consumer Price Index.Moneyzine EditorNovember 6th, 2024
The financial accounting term monetary items refers to those assets and liabilities whose value is measured and stated in cash. Examples of monetary assets include cash, accounts receivable, notes receivable, and investments. Examples of monetary liabilities include accounts payable, notes payable, sales taxes payable, and various accrued expenses.Moneyzine EditorFebruary 8th, 2024- The financial accounting term nonmonetary item refers to those assets and liabilities whose price in terms of dollars may change over time. Examples of nonmonetary assets include inventory, raw materials, property, plant and equipment. Examples of nonmonetary liabilities include warranties payable and deferred income tax credits.Moneyzine EditorSeptember 20th, 2023
