Financial statements should provide information that is both relevant and reliable. The current model upon which financial statements are based is the historical cost model. Over the past fifty years, however, various individuals and groups have

Question

advocated the implementation of current value models of accounting. One such model represents the amount of cash for which an asset might be sold or a liability might be refinanced, sometimes referred as the current-exit-price approach. The current exit price is generally agreed to correspond (1) to the selling price under conditions of orderly rather than forced liquidation, and (2) to the selling price at the time of measurement. All assets and liabilities are thus revalued at their exit prices at each reporting date. Required: Evaluate the historical cost and current-exit-price models in terms of relevance and reliability.

Answer 1

The historical cost model generally is viewed as strong in terms of reliability and weak in terms of relevance. Historical cost is seen as objective and verifiable. Historical cost may not be relevant to many decisions, however.

Accounting information must be capable of making a difference in a decision if it is to be relevant. The acquisition cost of an asset may have much less relevance to a decision than the price at which the asset would currently command in the market.

The current-exit-price model would provide values with greater relevance but perhaps less reliability. Establishing the selling prices of some assets might be difficult or even impossible unless the asset were actually sold. Further, business enterprises that prepare monthly financial statements would be faced with the burden of determining current selling prices on a monthly basis. Such a process could be time consuming and expensive thus resulting in the cost of the process exceeding the value of the benefit derived.