Question

diffferentiate historical cost concept from the fair value cost from the fair value cost concept of measurement.State clearly their advantages and disadvantages

Answer 1

Historical Cost concept: In Historical cost concept all the assets and Liabilities are recorded at their original cost I.e; at their cost of acquisition. Any adjustments to the assets are done separately and assets are shown at their original cost.

For example. If an asset is purchased for 1 lakh with the estimated life time of 5 years. Depreciation method is straight line method then in Balance Sheet annual depreciation of 20000 is shown separately as accumulated depreciation and value of asset is shown as 1 lakh.

Even at the time of its sale or disposal it calculated in terms of historical cost.

Advantages:

1. It is very easy to understand the accounting treatment.

2.There is no confusion in value of assets since there is no concept of market values.

3. Assets or liabilities doesn't appear in inflated rates.

Disadvantages:

1. The values appearing in Balnce sheet is not real so one cannot rely on balance sheet.

2. It confuses the investor while investing in company.

Fair value cost concept:

In fair value cost concept assets and liabilities are recorded at the fair value or present market value. i.e; Values prevailing at present market rates.Any adjustments to the assets and liabilities are directly made to the asset.

In the above example in fair value cost concept value of the asset in balance sheet is recorded as 80000 which is cost of asset less annual depreciation.

Advantages:

1. It is to find out the real value of the asset.

2. It doesn't confuse the investor while going through balance sheet.

3. It is widely used practising so very easy to compare financial statements.

Disadvantages:

1. Little difficult to understand to normal persons in case complex situations.

2. One should do lots research to know exact market value.