Accountants calculate the value of an plus by mention to the cost of acquisition, and non by mention to the value of the returns which are expected to be realized. This method of mensurating assets value takes penchant over other methods based on some signifier of current value.
Get Full Essay Get access to this section to get all help you need with your essay and educational issues. Get Access Fair Value vs. Thus leading to debates at what price — historical costing price or market value — assets and liabilities should be reported.
Therefore, before making any evaluations about reported transactions it is important to understand the difference between historical cost and fair value accounting.
Whereas historical cost accounting, as mentioned by Marshall, McManus and Vielep. Regarding only conceptual side of fair value and historical costing price Penmanp. In contrast, historical cost application shows the information through income statement, where earnings report value-added through arbitrage made by buying products from suppliers and selling them to customers at different price.
However, fair value income statement indicates the change in value during the period and reports management performance.
Besides, unexpected earnings in fair value income statement identify value at risk. After all, Penman made a point saying that in historical cost accounting revenues and costs have to be matched, but in fair value accounting balance is not required.
In comparison with historical cost, which is determined by simply recording the original cost taking into account depreciation, determination of fair value is more complex.
In their article Laux and Leuzp. It is said that prices in active markets with identical assets and liabilities are taken as a measurement for fair value.
But if such prices are not available one has to either look for a relevant observable market data or use model assumption and apply valuation techniques and significant adjustments in order to obtain fair value. Moreover, the author noted that when using fair value it is easy for management to manipulate with earnings, overstate or understate values as for their own good.
Furthermore, Marshall et al. Still, Laux and Leuzpp. Authors noted that because of the timely information provided by fair value it stimulates frequent corrections and increases transparency. These advantages lead to relevancy of fair value accounting, whereas lack of transparency and not up to date information makes historical cost accounting less relevant.
However, authors stated that relevancy can be applied to fair value only when regarding liquid assets, otherwise fair value accounting can generate misleading information.
Besides they have also noted that, while historical costs remain stable during all times fair value prices can be deformed by inefficient markets, liquidity problems or investors irrationality increasing volatility in financial statements.
What is more, Laux and Leuzp.
Nevertheless, in the article it is said that fair value not only provides more reliable and timely information for investors, but it also can be used to compare different entities more accurately then using historical cost accounting data.
Generally these are intangible and long-term assets which are reported at historical cost rather than fair value. However, in this article it is said that SFAS propose using fair value for impaired assets and their write-downs. The authors noticed that in FAS it is said to report trading securities and available-for-sale-securities at fair value, as well as use fair values for disclosures in the notes of financial statements FAS Considering all the information mentioned above, differences between historical cost and fair value accounting can be found in their definitions — regarding prices at the current date vs original cost; in concept — focusing on changes in market value vs looking at earnings from realized sales; in measurement — application of judgments and model assumptions vs identifying depreciation; in quality — relevance vs reliability; in implementation — liquid assets, impairments and disclosures vs long-term and intangible assets.
Since these differences also refer to strengths and weaknesses of historical cost and fair value accounting, after regarding them one should be able to make more accurate evaluation of financial statements reported at either historical cost or fair value.
Why historical cost accounting makes sense. Strategic Finance August The crisis of fair-value accounting: Making sense of the recent debate.
Accounting, Organizations and Society,34 6—7The historical cost principle is a trade off between reliability and usefulness. The historical cost of an asset is completely reliable.
After all, . The cost principle is one of the basic underlying guidelines in accounting. It is also known as the historical cost principle. The cost principle requires that assets be recorded at the cash amount (or its equivalent) at the time that an asset is acquired.
For example, if equipment is acquired for. Under the historical cost concept, business transactions are recorded at the acquisition cost, historical cost or the transaction price at the time of .
The historical cost principle states that the asset should include all cost necessary to get the asset in place and ready for use.
The principle of historical cost is based upon two fundamental principles: the principle of monetary Essay on The historical cost accounting convention. The principle of historical cost is based upon two fundamental principles: the principle of monetary standardization and principle of prudence.
The principle of monetary standardization ignores the fluctuations in monetary values of asset and liability. Limitations of Historical Costing in times of Inflation Historical Cost accounting and its significance History of Historical Cost Accounting Techniques of Historical Cost Accounting Conclusion References: 1 2 3 *** The impact of inflation comes in the form of rising prices of output and assets.