Historical Cost Approach and Conservatism Principle - Effect on Decision Making
ABSTRACT
Ravi Kumar (Ravi) started an agriculture equipment renting services business, Ravi Agriculture Services. He rented different types of farm equipment to facilitate faster processing of agriculture activities. He provided depreciation on the agriculture equipment and also followed a liberal credit and revenue recognition policy to ensure smooth flow of business operations, as well as meet the needs and requirements of the farmers. However, he faced problems in terms of replacing one piece of agricultural equipment. The cost of the equipment had increased over the years, and the increase could not be covered by the provision he had made for its replacement. This case study can be used to discuss the pros and cons of recording business transactions at historical cost, and also to discuss the principle of conservatism and how it facilitates the decision making process in business operations.
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Issues:
The application of the historical cost approach and its limitations .
The pros and cons of the conservatism principle.
The effect of the historical cost approach and conservatism principle on decision making.
Introduction
Ravi Kumar (Ravi) ran an agriculture equipment renting business in a town in southern India. The town was surrounded by several villages where the people were primarily engaged in agriculture related activities. Ravi rented out different pieces of farm equipment to the farmers in the surrounding villages (Refer to Exhibit I for Various Farming Equipment Services offered by Ravi).
While finalizing his yearly accounts, Ravi provided depreciation on all equipment @ 5% on a straight line basis (Refer to Exhibit II for Depreciation Charged on all Equipment since 2015-16).
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Keywords
Accounting; Accounting principles; Accounting Concepts; Historical Cost Concept; Conservatism Principle; Decision-making; Profit and loss account; balance sheet
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