The historical cost convention results in an appropriate measure of the economic resource that has been withdrawn or replaced. Under it, transactions are reported at the £ amount recorded at the date the transaction occurred. Financial statements produced under this convention provide a basis for determining the outcome of agency agreements with reasonable certainty and predictability because the data are relatively objective. By this we mean that various parties who deal with the enterprise, such as lenders, will know that the figures produced in any financial statements are objective and not manipulated by subjective judgements made by the directors. A typical example occurs when a lender attaches a covenant to a loan that the enterprise shall not exceed a specified level of gearing.
At an operational level, revenue and expense in the income statement are stated at the £ amount that appears on the invoices. This amount is objective and verifiable. Because of this, the historical cost convention has strengths for stewardship purposes, but inflation-adjusted figures may well be more appropriate for decision usefulness.
At an operational level, revenue and expense in the income statement are stated at the £ amount that appears on the invoices. This amount is objective and verifiable. Because of this, the historical cost convention has strengths for stewardship purposes, but inflation-adjusted figures may well be more appropriate for decision usefulness.