Question

Under GAAP, companies may apply various valuation methods in recording transactions and preparing financial statements, for example historical cost, fair market, replacement, depreciated or amortized cost, etc. For each basis in your discussion, cover its definition, describe in general terms when it is proper to use it, and critique the advantages and disadvantages of its use. Address the issue of why we should (or should not) use so many different valuation bases in GAAP. Is it accurate to claim that GAAP is still based on historical cost?

Answer 1

HISTORICAL COST

This is a measure of value in accounting in which the value of an asset is recorded as its original cost or the money actually paid for the assets, as acquired by the company. This method is generally used by the company for valuing fixed assets.

As per GAAP assets should be recorded at historical cost .the principle behind this method of accounting I s that the change in value of assets in form of physical deterioration is recorded through depreciation or amortization.

The advantage of using the above method is that it’s easy to calculate &reliable.

Fair market , this is a method where the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts. In other words , the price at which the property could be sold or purchased in an open market.

This is the fair value of the asset which is generally recorded in the balance sheet at the time of sale or purchase of asset, or diversion of business.

Replacement: Under this method , the value of the assets is recorded at which the assets can be replaced by the other one at the present time according to its current worth.

This method is generally used when where the company wants to replace the assets with new one .

Depreciated : under this method the value of assets is recorded at the current value i.e assets when bought at market value, then change in the value of assets due to physical deterioration , its use , in the form of depreciation . the value achieved after reducing depreciation from the original value of assets is the depreciated value of the asset.

This method is generally used to know the current value of the assets as on current date.

Amortized cost: Amortized cost is that accumulated portion of the recorded cost of a fixed asset that has been charged to expense through either depreciation or amortization.

It generally reflects the consumption of intangible/tangible assets over its useful life. It is very much similar to depreciation.