Question

Give facts and reason for each position

A) Position 1 – Historical cost: Present arguments that historical cost is more relevant than fair value.

B) Position 2 – Fair value: Present arguments that fair value is more relevant than historical cost.

Answer 1

A) . Position 1 : Historical cost is more relevant than present value :

1). Users of financial statements could know exactly the original value of assets or liabilities in the financial statements as it requires no adjustment through historical cost accounting.

2). Verifying the value of assets or liabilities base on cost basis is much easier than market value.

3). It is simple method which is easy to understand by management, accountant and auditor.

4). Accounting data under HCA are generally considered free from bias, independently verifiable, and hence more reliable by the investing public and the other external users.

5). Historical accounting reduces to a minimum the extent to which the accounts may be affected by the personal judgement of those who prepare them.

6). Being based on actual transaction, it provides data that are less disputable.

7). This method is least costly to society considering the social costs of recording, reporting, auditing and settling disputes.

8). It is only the legally recognised accounting system accepted as a basis for taxation, dividend declaration, defining legal capital etc.

B). Position 2 : Fair value is more relevant than historical cost :

1). With fair value accounting, it is total asset value that reflects the actual income of a company. It doesn't rely on a report of profit and losses but instead just looks at actual value.

2). Such method is able to make valuation across all type of assets, which is better than historical cost value which may change through time.

3). Fair value accounting helps businesses survive during a financially difficult time because it allows asset reduction.

4). With fair value method. valuations are more are more accurate, such that the valuations can follow when prices go up or down.

5). Historical cost is not tested for impairment loss on the balance sheet but fair value is tested for impairment annually.

6). Fair value refers to the actual worth of asset which is derived fundamentally and is not determined by the factors of any market forces.

7). Fair value is more commonly adopted and tested method in comparison with any other valuation methodology.