Historical Cost and Fair Value Essay

1.0 Introduction

There have been many treatments and arguments refering usage of just value accounting against usage of historical cost accounting. Some prefer just value whilst some have a penchant for historical cost accounting. Both methods of rating have been criticized and every bit good embraced.

It is apparent that a quality description and quantitative information about the nature of the fiscal plus is basically of import and the sum that is appraised from the chosen method of rating is included in the fiscal statements. The inquiry nevertheless remains as to which measuring method must one usage to get by with today ‘s complex fiscal instruments and hazard direction schemes. We must admit that we are in an epoch where we use many complicated fiscal instruments and hazard direction schemes which render that yesterday ‘s monetary values may hold become disused and many people now demand historical cost be either abandoned, reviewed, modified or replaced by current cost system to reflect a more accurate fiscal coverage ( Muller, K. A. , 2008 ) .

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The issue of assets and liabilities rating has become more urgent now than it was of all time earlier. The FASB[ 1 ]is easy overhauling the GAAP[ 2 ]rules and in making so, it is trying to do fiscal statements more meaningful and convey books in line with the international criterions.

Historical cost and just value methods of rating have both been around for a long clip. The pick of whether to exchange to fair value method is interestingly an of import determination where all positions have to be every bit evaluated in sing the passage from an bing to a new method of fiscal plus rating. History has proven that the historical cost rule has worked perfectly all right all this piece. This now poses us a inquiry as to why the consideration and guess to exchange to a new method of fiscal plus rating. What theories and what footing should drive the motive to take a varying method of fiscal plus rating and what could be ideally considered being the opportune clip for the switch in pick of theoretical account.

With the of all time increasing concerns between both the populace and private sectors refering to the adequateness of fiscal statement coverage by several fiscal establishments, a considerable attending has been received by the FASB, SEC[ 3 ]and other modulating organic structures.

The adaptation of the IFRS[ 4 ]in the European Union with consequence from 1st of January 2005 birthed a figure of important alterations in how houses must describe their fiscal places ( Muller et al 2008 ) . Measurement of fiscal assets is the nucleus issue of relevancy in fiscal accounting and coverage today.

In order to make up one’s mind which method of rating one must take, it is imperative that there must be a sound apprehension of the just value and historical cost method of rating for fiscal assets.

This seminar attempts to transport out an in deepness research on the just value and historical cost method of rating, understand the implicit in premises of each, place the strengths and failings of both.

Assorted companies has been researched and contacted in order to obtain feedback on their chosen method of fiscal plus and liabilities rating. Responses received are summarized in analysis and findings subdivision of this paper and has been deliberated upon in understanding how companies and organisations in Fiji are valuing their assets and liabilities for describing in their fiscal statements.

Besides encompassed are assorted literature and resource stuffs that we have studied. These have been reviewed and cardinal kernel and facets of subject under survey has been entailed in subdivision entitled Literature Review.


Accounting is extremely purposive field and any premise, rule or process is consequently justified if it adequately serves the terminal in position ( Paton, 1922 ) . There are many accounting conventions under the Generally Accepted Accounting Principles ( GAAP ) which is now known as IFRS.

Historical Cost Convention is the conventional rating construct whose resources are valued in conformity with the cost of acquisition by the endeavor ( Glautier and Underdown, 1982 ) . Assetss are recorded at their original cost at the clip of purchase. This convention is extremely preferred for the historical cost method over just value.

The Conservatism Convention assumes that comptrollers are pessimistic in mensurating grosss and disbursals. Grosss are non recorded until they were virtually certain but disbursals were recorded every bit shortly as they become distant. If comptrollers had to take for measurings of cost for assets and liabilities they would hold chosen the lowest for assets and highest for liabilities largely adopt historical cost method.

The historical cost of method is good preferred over the just value method as the Accounting as a Historical record is concerned at supplying a faithful record of dealing of an entity instead to supply a rating of the house at a given period of clip ( Godfrey et. Al, 2006 pg 18 ) .

While historical cost method may give some indicant to stockholders of the stewardship of direction in the direction of costs and money capital under the control, the records give no indicant of the existent worth of the endeavor as a traveling concern except to the extent that operating net income is a prognostic devise ( Budge and Hendriksen, 1974 ) .

Aim of stewardship is based on bureau theory. Directors ‘ pick of accounting method normally comes as bureau theory. Agency theory provides a necessary account of why a choice of peculiar accounting method might count, and hence was an of import aspect for the development of Positive accounting theory. It is assumed that under bureau theory principals will presume that the agents ( principal ) will be driven by self involvement and hence the principals will expect that the directors, unless restricted from making otherwise, will set about self functioning activities that could be damaging to the economic public assistance of the principals ( Deegan 2002 ) .

Since the behaviour of this principal can non be predicted as their wages are tied to accounting figures and supervising the chief behaviour is hard. The preparers of fiscal studies will take measurement footing for higher net income for the wage intents. It could be better if the peculiar method such as historical cost is stated in the contract of the principal for describing intent.

Watts and Zimmerman identified three key hypotheses that have become frequent in the Positive Accounting Theory literature to explicate and foretell whether an organisation would back up or oppose a peculiar accounting method.

A higher net income is precise under the direction hypothesis or fillip program hypothesis. The preparers of the studies will utilize such accounting methods that addition current reported income. Such method increases the present value of fillips if the compensation commissions do non set for the methods chosen. This hypothesis predicts that if directors are rewarded in footings of public presentation with accounting figures than troughs will take methods to increase accounting net income with an effort to increase fillip.

A higher net income is besides preferred by Debt Equity hypothesis which predicts that the

higher the house ‘s debt equity ratio the more likely the directors ‘ usage accounting methods that increases income. The higher the debt to equity ratio, the closer the houses to the restraints in debt compact. The tighter the compact restraint, the greater the possibility of a covenant misdemeanor and of incurring of costs from proficient defaults. Mangers ‘ taking income increasing accounting method relaxes debt restraints and reduces the proficient defaults ( Deegan 2002 ) .

The Political Hypothesis predicts the larger houses instead than little houses are likely to take accounting methods that reduces reported net income. Reducing reported net income could diminish the possibility that people will reason that the organisation is working other parties by using concern patterns that generate inordinate net income for the benefits of proprietors while at the same clip supplying limited returns to others parties involved in the dealing.

Chambers Theory of Continuously Contemporary Accounting made judgement about what people need in footings of information. Chamber makes an premise about the aim of accounting is to steer future actions. He prescribed that all assets should be measured at net market value and that such information is more utile for informed determination doing than information based on historical cost which could be misdirecting.

A figure of normative theories were developed which adopted Decision Usefulness attack to Accounting Theory. Chambers “ Blueprint ” paper published in 1955 is arguably among the first to emphasis determination usefulness.He wrote: ‘It is hence corollary of the premise of rational direction that there shall be an information providing system, such as footing for determination and as a footing for reexamining the effects of determination ‘ . It is suggested that accounting information should be relevant, verifiable, free from prejudice and quantifiable. The pick of Accounting Methods depends on factors such as dependability, relevancy, seasonableness and comparison.

Finally, there are several other theories to accounting which could explicate the pick for the sort of measurement base or method. Cost Attach theory, Investor theory, True income theory, Behavioral Accounting theory, Measurement theory, Accounting as Magic and communicating theory and others. Measurement is a hub of Accounting which has a batch of accounting theory implicit in measurement footing. The minimal demand for giving theoretical justification to an allotment method are that it should be possible to stipulate unequivocally and in progress, the method to be used and to support that pick against all viing options.


There has been much treatment about just value accounting. Unwraping assets at their just value as opposed to their historical cost is preferred by some but opposed by others. The usage of just value accounting has been around for decennaries chiefly for fiscal assets. In recent old ages, both the Financial Accounting Standards Board ( FASB ) and the International Accounting Standards Board ( IASB ) have moved towards more extended usage of just value accounting.

Harmonizing to Godfrey et Al ( 2006 ) the usage of historical cost for rating of non-monetary assets has come from several beginnings, these include the 1940 book by Paton and Littleton, An Introduction to Corporate Accounting Standards. The book provides many of the theoretical statements for the accounting. Historical cost is by and large defined as the sum at which the plus or liability was originally obtained. Where the historical cost is expected to be different from the concluding value when the point is no longer on the balance sheet, some amortisation or depreciation of the value is expected. This can ensue in an amortised cost or depreciated cost value. These values are by and large more faithfully determinable, but less relevant than just value.

Casonbona et Al ( 2007 ) define just value as the sum for which an plus could be exchanged or a liability settled between knowing, willing parties in an arm ‘s length dealing. This assumes that it represents market value in a sufficiently robust and efficient market. Where no market exists, the just value would necessitate to be conceptually estimated.

In doing comparings between the two, Toppe Shortridge et Al ( 2006 ) refer to an statement of relevancy over dependability. They argue that the advocate of just value accounting believe that historical cost fiscal statements are non relevant because they do non supply information about current values. Theorists and practicians against just value argue that the information provided by just value fiscal statements is undependable because it is non based on “ weaponries ‘ length ” minutess. They contend that if information is undependable it should non be used to do fiscal determinations. However they besides argue that the advocates of just value accounting would claim that it is more relevant to determination shapers even if it is less dependable. These statements include that just value accounting would bring forth balance sheets that are more representative of the company ‘s value. Specifically, unless the values of fixed assets are assumed to stay the same over clip, historical cost information is relevant merely up on obtaining the plus.

A figure of surveies have been conducted to reason that one method is more appropriate than another.

Ebling ( 2001 ) argues that accounting regulations around the universe are traveling steadily towards just value accounting and off from historical cost accounting. In his survey he argues that the banking systems figures would go more volatile. The Bankss would see their concern managed against long term aims and non “ short term ” steps and it is historical costs that better reflect the economic substance of the minutess, the existent hard currency flow and the net incomes procedure. Chisnall ( 2001 ) besides supports this position and argues that the banking industry as an illustration would be best to utilize modified historical cost as a better footing on which to mensurate banking book public presentation in primary fiscal statements. The issue of volatility has surfaced in recent times with the illustration of the prostration of Enron as an illustration.

Barr ( 2009 ) reflects that just value can be an accurate manner to value assets but it needs clip to be to the full perfected. With Enron just value accounting was used to misdirect investors, regulators and the general populace. Kemp ( 2008 ) argues that just value accounting works best where the legal model of society accepts the subjectiveness of the market and therefore divergent values as in Europe, as opposed the USA with its really unfastened legal system.

The disadvantages of just value are besides highlighted. It is argued that rating is a subjective judgement and hence as an illustration if two judges were to carry on the rating procedure they may get at different estimations of the just value although both would hold followed the aims of just value measuring.

There are many issues involved with just value accounting. Some argue that just value is good to investors when they are seeking to measure hazard, return and rating of a concern.

Dvorakova ( 2007 ) in her survey of historical costs versus just value measuring in fiscal accounting uses the illustration of non-financial assets. In her survey she notes that “ IAS 41- Agriculture ” sets a case in point in application of the just value measuring to biological assets and agricultural production. The survey states that the just value measuring has been required by IAS 41 because historical cost measuring is non able to cover the value of biological assets of endeavors in the market environment.

Muller et Al ( 2008 ) examine the cause of and effects of investing belongings companies ‘ pick to utilize the historical cost or just value criterion to account for their primary plus, existent estate. The scrutiny exploits the European Union ‘s acceptance of International Financial Reporting Standards which require companies to do this pick under “ IAS 40 – Investing Property ” . The survey showed that companies are more likely to utilize the just value criterion when a company shows a greater committedness to describing transparence. It showed that some companies nevertheless were besides timeserving in utilizing just value to describe larger additions than companies utilizing the historical cost criterion.

Christensen and Nikolaev ( 2009 ) studied whether and why companies prefer just value to historical cost when they can take between the two rating methods. Their survey show that with the exclusion of investing belongings owned by existent estate companies, historical cost by far dominates just value in pattern. They province that just value accounting is non used for works, equipment and touchable assets. They found that companies utilizing just value accounting rely more on debt funding than companies that use historical cost. This grounds is consistent with companies utilizing just value to demo plus settlement values to their creditors and is non consistent with equity investors demanding just value accounting for non-financial assets.

This survey was based on a sample of 1,539 companies. It identified each company ‘s rating pattern by reading the accounting policy subdivision in its one-year study. No companies in the sample used just value accounting for intangible assets. Merely 3 % used it for assets such as works and equipment. With really few exclusions just value is used entirely for belongings. The survey besides looked the balance sheets of the companies and found that that the entire assets and stockholders equity were, severally, 31 % and 88 % higher on norm for the companies utilizing just value as opposed to a matched sample of companies that merely utilize historical cost accounting. The survey besides proves that a assorted attack is taken to the usage of just value under “ IAS 16 – Property, Plant and Equipment ” .

The survey farther provinces that companies that follow historical cost accounting must sporadically prove their plus for damage. An plus is considered impaired when its carrying sum is higher than its just value less the costs to sell and the present value of future hard currency flows it is expected to bring forth. With historical cost accounting companies will in pattern value assets near to fair value if depreciated historical costs exceed just value. In contrast under just value accounting companies revalue assets either upwards or downwards depending on the alteration in the just value estimation.

Beier ( 2008 ) negotiations about measurement issues with bing assorted standard theoretical accounts. He

provinces that mismatches may happen because some assets and liabilities are reported at historical costs and some are marked to fair value. Examples he gives include ;

Fiscal establishments report many assets at just value and the debt used to finance those assets is reported at historical cost ;

Debt nominated in a foreign currency is translated at topographic point rate while assets financed with that debt is translated at historical rate ;

Derivative used to finance stock list are reported at just value while such stock list is reported at historical cost.

Grover ( 2008 ) in his expression at the argument of just value versus historical costs provinces that while there needs to be consistence in accounting it may be necessary to mensurate certain balance sheet points at just value and other at historical cost.

It can be argued from the literature and surveies conducted that just value and historical costs both have their topographic point in accounting. There are many different and alone sorts of concerns so one cosmopolitan criterion for valuing assets may be suited for some but non for others. Fair value is good due to its ability to supply an up to day of the month value of concern assets, but just value may besides inaccurately blow up the value of a company due to errors or deceits and in making so can falsely increase the assurance of investors and hence increase its capital.

Historical costs are good as it is widely understood by investors and companies. Historical costing does non trust on gauging the value of assets and therefore allows less room for deceitful activities to happen. However the usage of this criterion can undervalue the value of a company since an addition in the value of an plus is non recorded until the plus is sold or traded. Although this may do investors to wary of a company who has a deflated value it does supply more stableness in the market.

If both accounting criterions are used it can better meaningful information for determination devising. The usage of just value allows for an up to day of the month value of assets and produces relevant costs. As an illustration if a company owned a edifice the just value of that edifice will be the chance cost of that edifice in footings of it being sold or rented or used for something other the companies intended use. As historical value is more widely used and understood it can be used as an external usage of describing value of assets. Historical costs can be used as the base in describing value and just value used as an estimation or projected value of assets to investors.



To discourse the principle of historical cost and just value methods of measuring and determine whether it is appropriate to utilize both methods when roll uping a set of fiscal statements.


The range of our research aims to turn to the undermentioned issues ;

Discuss the principle of historical cost method.

Benefits and restraints of historical cost method.

Discuss the principle of just value method.

Benefits and restraints of just value method.

Whether it is appropriate to utilize both methods when roll uping a set of fiscal statements.

Benefits and restraints of utilizing both methods.


In roll uping this research undertaking, we used the following techniques to obtain informations which are as follows:

Questionnaire Distribution

We compiled inquiries and distributed to 30 describing entities in Suva and Nasinu country. These were given specifically to fiscal statement preparer ‘s viz. fiscal accountants and comptrollers.

Reappraisal of literature

We reviewed the research documents and diaries carried out by several research workers on just value and historical cost.

Online Research

Accessing the cyberspace played a critical function in obtaining current and up-to-date

Information sing historical cost and just value.


Question 1:

1. What method of measuring does your company presently use?

Upon analysing the results of the 25 received responses from the coverage entities, 1 utilizations just value method, 17 companies adopt to utilizing historical cost as measurement footing while 7 stated that they use both methods that is just value and historical costs. The tabular array below shows the methods used by the companies in roll uping the fiscal statements.


HC – Historical cost

FV – Fair value

Both – Historical cost and just value

What are the benefits ( advantages ) of historical cost did you see prior to implementing this measurement footing?

The responses received in respects to the advantages of historical cost method have been rather similar and we have analysed the advantages in the undermentioned classs demoing the figure of respondents.

What are the restraints ( disadvantages ) of historical cost measurement footing that your company may hold faced?

The responses received in respects to the disadvantages of historical cost method have been rather similar and we have analysed the disadvantages in the undermentioned classs demoing the figure of respondents.

The respondents of 68 % ( 17 out of 25 ) agreed that the benefits of utilizing historical cost ( Question 2 ) as its measurement footing outweighs the restraints identified in Question 3 while 32 % ( 8 out of 25 ) thought otherwise. The major concluding being that historical cost is reasonably easy to utilize and understand and besides in Fiji, there is restraints for deficiency of active markets for some categories of assets, therefore for rating intents, following to fair value becomes an expensive for undertaking for entities.

What are the benefits ( advantages ) of just value did you see prior to

implementing this measurement footing?

The responses received in respects to the advantages of just value method have been rather similar for most companies and we have analysed these advantages in the undermentioned classs demoing the figure of respondents.

What are the restraints ( disadvantages ) of just value measurement footing that

your company may hold faced?

The responses received in respects to the disadvantages of Fair value method have been rather similar and we have analysed these disadvantages in the undermentioned classs demoing the figure of respondents.

Make you see that the benefits outweigh the restraints in utilizing just value as the measurement footing?

Sing that merely 32 % – 8 ( 1 – FV and 7 both ) out of the 25 companies use just value, they responded that the benefit of the just value identified in Question 5 does outweigh the restraints in Question 6 while the 68 % ( 17 ) thought otherwise. We consider that the major factor behind this is due to miss of active markets for some assets whereby this becomes a cost restraint for entities and the complex nature of the methods used in just value.

Make you see that it is appropriate to utilize both methods when roll uping a set

of fiscal statements? If so, delight sketch the benefits and restrictions of

utilizing both methods i.e. historical cost and just value?

Of the 25 respondents, 19 ( 76 % ) of them view that it is appropriate to utilize both methods i.e. historical cost and just value when roll uping a set of fiscal statements while 6 ( 24 % ) of them view otherwise. The major concluding being that this would be more dependable and relevant for determination doing procedure such as for assets like Property Plant & A ; Equipment, entities consider utilizing historical cost footing of measuring since it is easy and efficient to utilize while for investings ; they consider just value since current and market rating is needed.

Furthermore, the entities ( respondents ) besides outlined benefits and restraints of utilizing both methods i.e. historical cost and carnival value which is analysed as follows:


In transporting out our research we encountered some jobs that we think have inherent this research and is outlined as:

Troubles were faced by the group in seeking responses to the questionnaires on the capable affair as some companies were loath to supply information due to the busy agendas of their employees and cardinal participants from whom information was required and besides private companies have rigorous confidentiality policies which restricted us in obtaining responses.

There is a possibility that questionnaires were likely to be filled out by comptrollers and history officers who do non hold cognition to that widen about their company ‘s policies sing measurement hence there is a opportunity for wrong informations.

Several companies refused to take part as they required traveling through the protocol of seeking permission from human resource section which was clip consuming.

Out of 30 questionnaires given, merely 25 responses were received. If all had responded, we would hold been able to garner more information which would hold enhanced our analysis and findings.

Likelihood of trying mistake as disadvantaged by geographical country. Due to clip restraints we distributed the questionnaires merely in Suva and Nasinu countries ; hence the survey of other describing entities from other parts could non be taken. If the questionnaires had been distributed to other part, so this paper would hold been more creditable and enlightening.

Excessive information based on abroad markets. This is a restriction as findings to Fiji ‘s context could non truly be made. Based on our readings, abroad markets have efficient markets whereas in the South Pacific it is limited to merely one.

Our group made an attempt to interview some companies nevertheless it was futile since they were unable to happen a reciprocally convenient clip.


7.1 Recommendations

Based on the research and in support of our decision, we recommend that:

That the professional accounting organic structures should go on to turn to the issue of measuring to supply with a solution. Accounting professional organic structures such as AASB, FASB and IASB should be specific in their conceptual model which measuring method should be used for different assets and be consistent across all boundary lines.

Accounting professional organic structures such as AASB, FASB and IASB should supply conceptual model for measuring such as on graduated table of concerns that is little size concern, medium size and big concern.

Further surveies to be carried out on the assorted method theoretical account rightness, integrating the positions of other stakeholders such as users given our narrow range of research every bit good as demand to confer with a more representative sample of all stakeholders given our little sample size.

7.2 Decision

Paragraph 100 of the IASB Framework states that: “ A figure of different measuring bases are employed to different grades and in changing combinations in fiscal statements ” . However, there is a deficiency of counsel in the model in supplying standards for choosing measurement footing for peculiar elements of fiscal statements. Although accounting patterns have changed well, still an overpowering big bulk of minutess is recorded and reported based on historical cost as it was centuries ago ( Ijiri, 1975 ) .

Our decision is that it is appropriate to utilize both historical cost and just value when roll uping a set of fiscal statements. This decision is based through prudent rating of old researches and the findings from the responses to our research questionnaire and therefore it is conclusive that there is no ideal method for plus measuring.

There is satisfactory research to back up that just value provides and enhances the relevancy of fiscal information particularly to assets with bing markets. However, this survey identifies that in Fiji historical cost is the most preferable method for most houses and this may be of the fact that Fiji has many little to medium graduated table of concerns.

Although just value is included in the conceptual model of accounting, there is deficient empirical grounds and literature that views it to be the best method. Historical cost method reduces a figure of jobs, including information use by directors, which further affects its dependability in determination devising. Furthermore, development of stiff accounting criterions is imperative to increase dependability of just value.

Paragraph 101 of the IASB Framework states that “ in fixing fiscal statements historical cost is normally combined with other measuring bases ” . Given that the model does non explicitly rebut and challenge such attack, utilizing both just value and historical cost at the same time is non precisely deemed to be unprincipled. By utilizing just value, information becomes more relevant to decision-making procedure as it reflects up-to-date information. Even though just value may be relevant, its dependability is questionable due to its subjective nature of finding. Last, by utilizing both methods we are able to bask the benefits built-in in just value every bit good as historical cost. One can reason that by uniting the two, the studies go unfastened to disfavor inherent in the two as good.


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