Financial reporting requires extremely accurate form of measurement to deliver information to lenders and shareholders who are obliged to know how wisely their money is being spent (Barth 2007). Van Zijl & Whittington (2006) reveal that the current form of measurement is increasingly emphasizing on the use of current value to replace historical costs. The principle reason behind the establishment of accounting standards was to ensure that financial information produced by organizations are accurate, reliable, complete, timely and relevant. In addition, accounting standards would ensure that organizations not only demonstrate accountability but also maintain it while meeting statutory reporting requirements such that the stakeholders are accounted for organizational financial performance to support decision making (Cooper 2007). Currently, the measurement basis for measuring amounts in financial statements includes among others historical cost, amortized historical cost, fair value and value in use. This paper evaluates the pros and cons of fair value versus historical cost accounting and deprival value. 1.0. Current cost should be used in financial reporting Historical cost accounting works well for liabilities that are not traded; representation of liabilities for contractual business obligations like long term deferred revenue, and other complex issues of life insurance and pension liabilities (Macve 2010). However, more emphasis is given to existing stakeholders and stewardship compared to service to investors in capital market and usefulness in economic decisions emphasized by fair value approach which replaces historical costs (Whittington 2008). Historical cost accounting and deprival value characterize the conceptual framework of ASB while fair value is a recent concept that is available only for the last 20 years in FASB, the IASB and the ASB and is increasingly applied in financial reporting. Penman (2007) argues that while historical cost accounting has been used in items whose measurement using fair value would be unreliable or expensive to quantify, fair value is considered to be informative given that it is applied within mixed measurement system. Defining and measuring current value Fair value is defined by Penman (2007) as the amount that would be obtained from selling an asset or the amount that would be given away in defrayal of a liability in a transaction deemed as methodical and between wiling and well-informed participants. As a result, fair value accounting information reflects the future and not the past, events or transactions (Whittington 2008; Barth 2006). Barth (2007) reveals that the measurement decisions are made by standard setters through focusing on the application of the definitions of elements in financial reporting and the qualitative attributes of accounting information on the basis of financial reporting objective. The use of qualitative attributes is intended at recognizing the desired measurement characteristics while the financial reporting objective brings out the context within which the evaluation of measurement will be evaluated (Barth 2007). 2.0. Importance of deprival value concept Van Zijl and Whittington (2006) argue that deprival value is the implying measurement at substitute cost for an asset that has a recoverable amount superior than the costs to be incurred for replacement. The value of an asset is restricted to replacement costs since the loss incurred in losing an asset
THE PROS AND CONS OF FAIR VALUE VERSUS HISTORICAL COST ACCOUNTING AND DEPRIVAL VALUE Institution name Introduction Organizations are expected to keep track of their state of affairs and performance over specified time duration using numerical financial reports…
The loans had collateral placed for them. The money was used to purchase subprime instruments like commercial papers. These instruments were trading fairly in the active market prior to the crisis. The observable market prices were used to measure fair value.
Since the US GAAPs are also closely linked to IFRS, FASB wants to bring some change in those GAAPS. To move towards fair value accounting, it published a statement on which it defined fair value accounting and provided some guidelines regarding it it also issued a standard in 2007 giving companies an alternative to value assets and liabilities at fair value .
An example of this may be an antique piece or jewellery which require the eye of an expert to discern true worth. It may also be the other way around, that an asset of low intrinsic value or poor income potential gets sold anyway at a high price, because the buyer did not know better but was induced by rumor or sales talk.
One of the most distinguished differences between these two lies in their definitions. While historic cost is the amount at which the asset or liability was originally obtained, fairvalue is the amount at which the asset could be exchanged or a liability settled between knowledgeable, willing parties in an arms length transaction.
Fair value is used to represent true value of an asset when the actual cost can not be measured with certainty in absence of actual exchange.
This IFRS specifies the accounting mechanism for non - current or fixed assets that are held for sale; and the accounting presentation and disclosure of discontinued operations.
The same act stipulates that Fair Value is to be determined as follows:
2. when there is infrequent activity in a market, the market is not well established, small volumes are traded relative to the asset or liability to be valued, or a quoted market price is not available- an estimate of a price for the asset or liability in an active or liquid market." (Australian Prudential Regulation Authority)
to accounting using asset values based on the actual amount of money paid for the asset with no inflation adjustment while fairvalue accounting refers to the value of an asset or liability using an arms length transaction between unrelated,
But after the financial crisis, the opponents of the Fair Value Accounting method pointed out that the fair value accounting method was one of the main factors which intensely fuelled the financial crisis. On the
9 pages (2250 words)Essay
Got a tricky question? Receive an answer from students like you!Try us!
Let us find you another Essay on topic The cons and pros of fair value versus historical cost accounting and deprival value for FREE!