a. The Strengths and Weaknesses of Historical Cost Accounting

The main strengths of adopting historic costs are as follows:

• it is easy to understand;

• it is objective as the original costs are usually factual;

• it can be reliably measured;

• it has been used since accounting began, so users are familiar with it.

The main weaknesses, however, are that:

• for non-current assets, historic cost bears no relation to their actual value;

• depreciation is inadequate to replace the asset;

• holding gains are included in profit whereas they are needed to maintain the existing operating capacity of the business;

• assets which have no original cost are ignored (e.g. homegrown brands).

b. Why Current Value is More Appropriate for Financial Instruments

Financial instruments have always been very volatile in terms of their valuation. They vary as the stock market, interest rates and exchange rates change; thus to keep them at their historic cost would not reveal their true worth which is important, as they can crystallise very quickly into real assets or liabilities. Only by keeping the values up to date can users have any confidence in their overall worth.

Financial instruments can often have no initial cost as their value derives from an underlying financial instrument, so if they were to be recorded at cost they would not appear at all on the balance sheet. In that case it is essential to fair value the instruments so that users have a better idea of what impact they would have on...