Hisorical Cost vs Fair Value

Topics: Balance sheet, Generally Accepted Accounting Principles, International Financial Reporting Standards Pages: 9 (2984 words) Published: December 18, 2012
The following are three online journals of Historical Cost and Fair Value: 1. Summary of HISTORIC COST VERSUS FAIR VALUE
In accounting historical cost is the original or nominal amount of money paid for asset rather than inflation adjusted price. In other words it is the resource given up or a liability incurred to acquire an asset. The historical cost principle states that the asset should be reported at it cost (cash or cash equivalent amount) at the time of exchange and should include all cost necessary to get the asset in place and ready for use. Fair value is the market value of asset or liability. According to GAAP(Generally Accepted Accounting Principles) it is the amount at which asset could be bought and sold in current transaction between willing parties other than liquidation sale. In fair value accounting companies are to report asset and liabilities at price they would receive if they sell the asset or pay for the liabilities. Fair value accounting is conflicting to prudence concept which requires not overestimating revenues and underestimating expenses. It believes in being conservative in recording the value of the asset and not to underestimate liabilities. The matter of contention that arises is that the interpretation of financial reports according to fair value is different to historical cost. The concern is to determine which is more true and dependable. The main justification for choosing historical cost is the accuracy of data whereas fair value believes in getting closer to the current value in market .

Historical cost is an old accounting principle since June 1979 which was used in French accounting plan project. Historical cost is truly more sure, reliable and checkable value. For asset it is the amount paid or to be paid and in case of debt it is the value of equivalents obtained in exchange of obligation or the value to be paid in cash or cash equivalents to settle the debt. But the major inconvenience is inflation which makes historical cost an obsolete or antiquated value. The change should be made through re-evaluation or inflation-indexed accountancy although it gives accurate picture. Historical cost being reliable still under-evaluate assets as compared to the market. Sometimes assets are even over-evaluate or under-evaluate through amortization and depreciation since companies have freedom to evaluate at the end of each fiscal year or period. Historical cost which is based on two fundamental principles, the principle of monetary standardization and principle of prudence which require to record according to acquiring cost. At times of inflation it increases company's profit which leads to paying more taxes and distribution of artificial dividends out of company's owned capital. Moreover for companies in the service sector or which invest huge amount of capital in technology reflects poorly the true potential. According to prudence concept it accumulate all losses not profit which hide its real potential. The adoption for the first time of International Financial Reporting Standard (IFRS) is replaced by IFRS1 which require to display all comparative and historical data formally for evaluation. Moreover some companies report according to GAAP and IAS1 should make it visible that the data is not according to IFRS and describe the adjustment to make it conform to IFRS. Companies should also explain transition from GAAP to IFRS has affected their financial position, performance and changes in cash flows. A new performance index called comprehensive income has appeared according to FAS130 in USA by FASB, it represent all the changes in owner's capital increases income before value adjustment(change in asset or liability before the end of the period which does not match with the initial record of asset or liability). Not used !!!!

The concept of fair value came in 1953 for the first time in publication of Accounting Research Bulletin related to re-evaluation. Later it came in...
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