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Unformatted text preview: Issues in Accounting Education Vol. 11, No. 1 Spring 1996 On the Role of Historical Cost Reporting Anil Arya, John C. Fellingham and Richard A. Young ABSTRACT: This teaching note illustrates how reporting historical data, even when it is unverifiable, can be useful in improving productive efficiency. Histori- cal cost accounting is evaluated in a simple multi-person setting with trading frictions in the form of restricted access to capital markets and private informa- tion. In one period these frictions result in no production and no use for cost reports. Surprisingly, repeated interactions allow improvements in productive efficiency and make cost reports valuable. Since the source of contracting fric- tions is not risk aversion, the analysis can be addressed using linear program- ming. T INTRODUCTION HIS teaching note explores ration- ales for historical cost account- ing.^ Often accountants disclose the results of already-entered-into trans- actions. That is, they often write things down after they have already happened. Why is it useful to do this; isn't the in- formation provided too late? There are three common answers to this question: 1) Learning Historical data may allow us to leam something about the future. For ex- ample, an increase in the level of sales this year may on average be followed by an increase in the level of sales next year.^ 2) Informativeness Historical data may be informative about a manager's unobservable ac- tions. A firm manager who antici- pates that his or her performance will be based on historical data may be more likely to act in the interests of owners.^ 3) Verifiability Historical data is based on transac- tions which are by their nature more easily subject to verification by third parties (e.g., auditors) than are other data, such as management's expec- tations about future values.* This paper seeks to convey a differ- ent story: the use of historical reports expands trading opportunities and may * The analysis herein is based on Fellingham and Young (1990) and Arya et al. (1994). 2 The statistical inter temporal relationship be- tween accounting disclosures has been explored in the accounting literature, e.g., Foster (1977). 3 Antle and Demski (1988) illustrate the useful- ness of accounting information for controlling management activity. « See Ijiri (1975,1981). Anil Arya, John C. Fellingham, H. P. Wolfe Chair in Accounting, and Richard A. Young are all at Ohio State University. The authors gratefully acknowledge the help- ful comments of the editor and two anony- mous reviewers, as well as students and fac- ulty at University of Illinois, University of Iowa, University of Notre Dame, Perm State University, Ohio State University and Univer- sity of Texas at Austin. Special thanks to Joel Demski, Rajib Doogar, Mitchell Farlee, Thomas Frecka and Douglas Schroeder. 16 Issues in Accounting Education improve productive efficiencies. Produc- tive inefficiencies occur in our model for three reasons: (1) the manager's access...
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