Question

Measurement Principles HISTORICAL COST PRINCIPLE (or cost principle) dictates that companies record assets at their cost. FAIR VALUE PRINCIPLE states that assets and liabilities should be reported at fair value (the price received to sell an asset or settle a liability). Selection of which principle to follow generally relates to trade-offs between relevance and faithful representation. Helpful Hint Relevance and faithful representation are two primary qualities that make accounting

I can't understand ( Selection of which principle to follow generally relates to trade-offs between Relevance and Faithful Representation )

this sentence is not clear for me. Can you give me an example and explain it to me.

For purchase of land why I select Historical cost principle not fair value principle ?

Answer 1

Trade offs between relevance and faithful representation is acheiving a balance between the two important factors that decides the usefulness of the Information generated using accounting principle

Faithful representation is producing results that accurately reflect the true and fair picture(position) of the business and it is expected to be error free.

Relevance relates to usefulness.Relevance in a financial information talks about how important it is to influence decisions among its users. Relevance is also about how well the information can be understood, compared and interpreted by its users.

Principle that is selected should always reflect a tradeoff (balance) between relevance and faithful representation. In simple words ,Principle chosen should provide relevant information that gives true and correct picture of the financial position of the entity.

For Eg: Imagine a company designs its own Plant and Machinery which is completely unique and tailor made to suit its business. It is no where available in the open market as it is custom designed to suit this company alone. Do you think you will be able to get fair market value of such Plant and Machinery or equipment from the market every year end to record the same based on its FMV?  

Answer is No: Such Type of Unique assets will not have a comparable FMV .So it is generally recorded using its Historical cost and depreciation is charged based on its usage. When you wish to sell this asset you may not find a immediate buyer and sometimes it can be sold only along with sale of business(cannot be used Individually by buyer for a different purpose other than for what it was manufactured or designed)

Land is one such long term asset whose value is not dependant on frequent changes in market conditions like shares or stocks.  Generally land is not bound to depreciation. Land is not traded frequently to use FMV Principle. In Historical cost accounting you can also trace the amount recorded from supporting source documents obtained when purchased. Fair market value of land cannot be easily obtained as it is based on several factors like location (area) square feet and amenities situated nearby etc. FMV of land is not easily ascertainable from relevant and trustable sources unlike FMV of marketable securities which is available in stock exchanges on daily basis. I

Also if Land and building are inseparbale land cannot be sold separately and you cannot get a comparable Market value for such land and building to value it on the basis of FMV

Land can be revalued after a span of few years from registered valuer and revalued amount can be shown in books to reflect true picture( position) of the company but Land cannot be valued every year using  FMV principle as it is not feasible and will not be a trade off between relevance and faithful representation