Historical Cost Profits and Losses

A memorandum item in the annual accounts and report of a company giving an abbreviated restatement of the profit and loss account showing the reported profit or loss as if no revaluations had been made.

Definition

Historical Cost Profits and Losses represent a memorandum item included in a company’s annual accounts and report that presents an abbreviated restatement of the profit and loss account. This restatement shows the reported profit or loss as if no asset or liability revaluations had been conducted.

Examples

Example 1: Asset Revaluation Impact

A company with machinery worth £100,000 initially (historical cost) and revalued at £150,000 will show higher depreciation expenses post-revaluation. The historical cost profits and losses will depict the profit as if the machinery depreciation was still based on the original £100,000 value.

Example 2: Real Estate Property

A real estate company owns a building acquired for £200,000 (historical cost), later revalued at £300,000. The revaluation increases depreciation expenses, reducing reported profit. Historical cost profits and losses will show profits assuming the building was still valued at £200,000, excluding the revaluation impact.

Example 3: Investments

An investment firm initially acquired stocks for £50,000, now revalued at £70,000. Profit adjustments consider this £20,000 gain. Historical cost profits and losses will exclude this gain, presenting profits based on the initial £50,000 acquisition cost.

Frequently Asked Questions

1. Why include historical cost profits and losses in reports?

It provides stakeholders with a clearer view of the company’s performance, independent of asset revaluations, facilitating better comparisons over time.

2. Are all companies required to report historical cost profits and losses?

Previously under FRS 3, it was required. However, under the new Financial Reporting Standard Applicable in the UK and Republic of Ireland (FRS 102), it is no longer mandatory.

3. How does historical cost affect profit statements?

By excluding revaluation effects, it shows profit based on original acquisition costs, offering a conservative and consistent profit measure.

4. What’s the difference between FRS 3 and FRS 102 regarding historical cost notes?

FRS 3 required the inclusion of such notes; FRS 102 deems it optional, reflecting evolving views on the utility of these disclosures.

5. Can historical cost profits and losses mislead investors?

They can present a simplified view, potentially misleading if not supplemented with revaluation details and other financial reports.

Fair Value

The price at which assets or liabilities could be exchanged in an orderly transaction between market participants at the measurement date.

Revaluation Reserve

A reserve created when assets are revalued upwards, reflecting unrealized gains due to the appreciation of asset values.

Depreciation

The systematic allocation of the depreciable amount of an asset over its useful life.

Financial Reporting Standard (FRS)

A set of accounting standards and guidelines designed to ensure consistency and transparency in financial reporting.

FRS 3

Financial Reporting Standard 3, which outlined the requirements for reporting financial performance, including the historical cost memorandum item.

Online References

Suggested Books

  • “Financial Accounting and Reporting” by Barry Elliott and Jamie Elliott
  • “UK GAAP 2019: Generally Accepted Accounting Practice Under UK and Irish GAAP” by Ernst & Young LLP
  • “Advanced Financial Accounting” by Richard Lewis and David Pendrill

Accounting Basics: “Historical Cost Profits and Losses” Fundamentals Quiz

### What does the historical cost profits and losses note display? - [x] Profits or losses as if no revaluations were made. - [ ] Actual market value profits or losses. - [ ] Future projected profits or losses. - [ ] Industry benchmark profits or losses. > **Explanation:** The historical cost profits and losses note displays profit or loss figures as if no asset revaluations had been conducted. ### Does FRS 102 require the inclusion of historical cost profits and losses? - [ ] Yes, absolutely. - [ ] It mandates it strongly. - [x] No, it does not require it. - [ ] Only for assets above a certain value. > **Explanation:** FRS 102 does not require the inclusion of historical cost profits and losses notes, differing from the earlier requirement under FRS 3. ### Which previous standard required the inclusion of historical cost profits and losses? - [x] FRS 3 - [ ] FRS 104 - [ ] FRS 105 - [ ] FRS 102 > **Explanation:** FRS 3, Reporting Financial Performance, previously required companies to include a note on historical cost profits and losses. ### How can historical cost profits and losses be useful? - [ ] Showing projected future earnings. - [ ] Excluding depreciation impairments. - [x] Providing a profit view independent of revaluations. - [ ] Reflecting actual market values. > **Explanation:** They provide a view of profits independent of revaluations, useful for conservative and historical comparison analyses. ### Historical cost profits and losses help in comparing financial performance over what? - [x] Different periods. - [ ] Different sectors. - [ ] Different companies. - [ ] Different countries. > **Explanation:** They aid in comparing financial performance over different periods by eliminating the volatile effects of revaluations. ### What aspect does historical cost specifically emphasize? - [ ] Market values. - [ ] Future potentials. - [ ] Depreciation. - [x] Original acquisition cost. > **Explanation:** Historical cost emphasizes the original acquisition cost, disregarding revaluations, thereby reflecting more stable and conservative profit measures. ### Which is not a common related term to historical cost profits and losses? - [ ] Revaluation reserve. - [ ] Depreciation. - [ ] Financial Reporting Standard. - [x] Revenue recognition. > **Explanation:** While revaluation reserve, depreciation, and financial reporting standards are related, revenue recognition pertains differently and is not a directly related term. ### What could be a drawback of only showing historical cost profits and losses? - [x] Ignoring current market conditions. - [ ] Being overly complex. - [ ] Lacking comparability. - [ ] Varying regulation adherence. > **Explanation:** Only showing them may ignore current market conditions and actual values, leading to potential under-reporting of asset values. ### Why might investors distrust only historical cost profit notes? - [ ] They are overly detailed. - [ ] They are difficult to understand. - [x] They exclude market value fluctuations. - [ ] They include foreign currencies. > **Explanation:** Investors might distrust them because they exclude market value fluctuations, potentially not reflecting the real-time financial position. ### Which financial statement item is directly influenced by the concept of historical cost? - [ ] Income Tax Payable - [ ] Cash Flow Statement - [ ] Owner's Equity - [x] Depreciation Expense > **Explanation:** Depreciation expense is directly influenced by historical cost, as it can be calculated based on the asset's original acquisition cost.

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Tuesday, August 6, 2024

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