Historical Cost Versus Fair Value Accounting For Non-Financial Assets

free essayThe choice between historical cost accounting and fair value accounting has been a question of debate in the international scene. A particular measurement has not been provided by the conceptual framework that deals with financial reporting in the international scene. The analysis methods recommended for financial reporting are stipulated according to the international financial reporting standard in order to make a free choice as to whether to use historical accounting or fair value accounting.

The Measurement Concepts according to Current IASB Framework and IFRS 13 Fair Value Measurements

The current IASB Framework and IFRS 13 on Fair Value Measurements clearly stipulate application of the concepts in relation to historical cost accounting and fair value accounting. These regulations are adopted by all countries globally and are recognized as the standardized rules for accounting. Whether a company decides to use the historical cost accounting concept or the fair value accounting theory, the IASB Framework and IFRS 13 Fair Value Measurements must be applied (IFRS Foundation n.d.). Therefore, a company is obliged to stick to one measurement concept throughout its accounting period to ensure consistency and reliability of the records kept. In addition, the dynamism experienced in the fair value measurement has created flexibility and accountability, thus reducing the financial risk companies are exposed to.

To begin with, the historical cost accounting theory requires an organization to state the value of its PPE in its historical cost in which it was acquired. This means that a company does not need to anticipate any possible loss or depreciation in the value of the PPPE during its existence in the company. Moreover, the historical cost accounting concept does not regard that reduction in PPE, as well as loss or damage of such PPE directly affect the value of PPE. Therefore, historical cost accounting concept will record the amount of PPE in the historical cost of its acquisition and give no consideration to the depression, loss in value or damages caused to the PPE that will lead to reduction in the value of PPE. Moreover, other factors that may lead to appreciation in value of PPE are not given preference in historical cost accounting.

On the other hand, the fair value accounting concept states the value of PPE in its current market value. The IFRS 13 Fair Value Measurement stipulates that all PPE must be reported at their current market price. Thus, this provision requires the management to consider such aspects as depreciation and loss in value of PPE, which may lead to a decrease in PPE value in the future. Other factors, such as capital adjustments and appreciations in PPE, which may lead to increase in the value of PPE, are also taken into consideration. Besides, the reporting of such PPE must be in line with the recommended depreciation and appreciation rates. Similarly, internationally recognized capital adjustments must be taken into account (Christensen, Hans & Nikolaev 2013).

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The Benefits and Challenges of Using Historical Cost and Fair Value Accounting For PPE and Intangibles. Reviewing Accounting Literature

Both historical cost accounting and fair value accounting pose benefits and challenges to the company. Application of these accounting concepts must be scrupulously done to ensure that all records of the company are beneficial to the organization and credible for any references. Moreover, regardless of the benefits and challenges, the accounting concept adopted by an organization must create accountability from all the PPE owned by the group. By reviewing the accounting literature as provided for in the International Accounting Standard (IAS), International Financial Reporting Standard (IFRS), and IASB Framework on accounting concepts, the application of the two concepts will cause benefits and challenges depending on how careful they are applied. However, neither of them has been proven to be superior to the other in any way. Several speculations have also been proven wrong as to whether application of the two concepts adversely affects a company.

To begin with, the historical cost accounting concept is easy to produce, which provides clear information about the PPE of an organization. Moreover, this accounting concept does not account for any gain or loss until such balance sheet item is realized. This means that historical cost accounting does not record imaginary information, creating a good record of what exactly transpires in the business instead. This concept is also dynamic, which makes it applicable in a number of organizations. It determines that financial statements will be accessible and accurate after the comparison of two companies. Historical cost accounting is preferred for its real valuation consideration since it incorporates all expenses related to PPE and intangibles. It helps a company prudently account for all costs related to its PPE and intangibles without mistreating such transactions. The final value of PPE and intangibles in historical cost accounting is void of any missed recorded capital expenditure (Missonier-Piera & Franck 2007).

On the other hand, the historical accounting concept poses some challenges to any organization that applies accounting. It will not give the actual value of PPE of a company due to the prevailing market prices. Moreover, the opportunity cost associated with using old items is ignored. In addition, the loss of the actual value monetary PPE, especially in times of depreciation, is not taken into consideration. It implies that the financial statements presented in historical cost accounting will greatly vary from the real balance value of a company’s PPE. Its main challenge is inaccuracy of PPE information. Thus, investors will not find this work reliable enough when making decisions concerning the fate of the PPE and intangibles of a company. The company will need the services of a professional valuer to ascertain the exact value of its PPE and intangibles.

Fair value accounting concept helps a company to keep updated value of its PPE on a regular basis. In addition, fair value accounting is accurate and precise in providing PPE valuation of a company, which is considered the best option. It can provide the exact value of the PPE according to the current market price. Moreover, fair value accounting provides more current information that increases the visibility of a company’s PPE financial status. The depreciation and appreciation that result from the use of the PPE are taken into consideration. What is more, the opportunity cost of utilizing the PPE and intangibles is not ignored at all (Missonier-Piera & Franck 2007).

The challenge faced by fair value accounting is its volatility that may lead a company to a financial risk crisis. Moreover, it allows the dynamism within accounting standards to influence the amount, which has to be documented in the company’s record. Nonetheless, fair value accounting assumes the existence of a liquid market for all companies. This means that fair value accounting measures are likely to plug a company into financial risk in the long run. Additionally, it is difficult to determine the standard rate when applying the deductions and increments in the value of PPE and intangibles. This makes various companies use different rates for the same class of PPE and intangibles.

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Valuation Practices of PPE and Intangibles According to the ‘Accounting Policy’ Sections of Three Listed Companies’ 2014 Annual Reports

The valuation practice for PPE and intangibles in the three countries is historical cost accounting. For instance, the accounting policies for Motor, a public company listed on the New-York stock exchange, show that the company uses historical cost accounting concept to value its PPE and intangibles. The same case is with Gen. Electric Company that is listed on New-York stock exchange that applies historical cost accounting to state the value of its PPE and intangibles in the stock market. From its accounting policies annual report in 2014, the company has been consistent in applying historical cost accounting to record its PPE and intangibles. Similarly, the accounting policies of A-CAP Resources Limited, a company listed on Australian Security Exchange, show that the company is applying the historical cost concept to record the value of its PPE and intangibles. It clearly indicates how the three companies have been consistent in reporting their PPE and other intangibles (ASE 2015).

Consistency of Valuation Practices for PPE and Intangibles across the Three Companies

The accounting and valuation practices of the three companies are consistent throughout their trading period. This is shown by the accounting policies in 2014 financial statements. Moreover, the three companies are seen to have adopted the same accounting concept, namely the historical accounting concept, to record PPE and intangibles in their books of account. This is because all the three companies are governed by the IFRS and other IAS that regulate the accounting principles and concepts worldwide. Moreover, all the countries, in which the three companies are domiciled, have adopted the international valuation practices. Thus, the assessment methods for PPE and intangibles are consistent across the three selected companies (IFRS Foundation n.d.).

The information from the respective stock and security exchanges indicates that the three companies have maintained the use of historical accounting concept to report their PPE and intangibles since their listing. Similar regulations and guidelines are being followed across the three companies in regard to the conceptual framework for international financial reporting, also referred to as the IASB Framework. Moreover, the three companies have remained consistent in their use of historical cost accounting to record their PPE and intangibles as required by the International Financial Reporting Standards. Despite the fact that the IFRS provides for free choice between the historical cost accounting and the fair value accounting for intangibles and PPE, it does not allow companies to be inconsistent with the concept they decide to adopt (ASE 2015).

Opinion on the Free Choice between Historical Cost and Fair Value Accounting For PPE and Intangibles

The free choice on historical cost accounting versus fair value accounting is a good way of giving freedom to companies to adopt a method that best suits their nature of business operations. The practice has created considerable flexibility and consistency among companies, each of which sticks to its own preferred accounting principle. Application of the two accounting concepts must be done within defined context to avoid misleading information as a result of weak regulatory frameworks.

The free choice between historical cost accounting and fair value accounting should be continued in practice. This will ensure consistency and reliability of the organization’s accounting records. Hence, a company needs to adhere to its own method of accounting that has been adopted by management to avoid confusion from now forward. In addition, continuity in the free choice of accounting creates accountability for the management of a company to keep up-to-date accounting records of the organization. However, neither of the two accounting concepts is superior to the other. The two provide critical information under diverse contexts within a company’s PPE valuation. The free choice between the two accounting concepts must be guaranteed and allowed to prevail in order to prevent any financial risk in PPE valuation.

Nonetheless, the International Financial Reporting Standard provides for the free choice between historical cost accounting and fair value accounting. Despite the fact that this has resulted in variation in the value of PPE and intangibles, it gives a company a flexible mode of proper accounting for its own PPE without any difficulty. Thus, the practice of free choice between the two accounting concepts should be encouraged to promote more accountability and credibility of the financial statements provided by the company’s management. Besides, the implementation of the free choice between the two accounting concepts reduces the financial risk that a company may face in future. All these aspects justify continuation of free choice between the two accounting methods.

Conclusion

The concept of historical cost accounting versus fair value accounting for non-financial assets has been widely used by companies in computing their PPE value. Nevertheless, the impacts of fair value accounting application are adverse given the high volatility it poses. Both accounting concepts are beneficial to the company. The only difference between them is that historical cost accounting recorded the value of non-financial assets in its initial value when the transaction took place. These costs will include all other costs related to bringing the asset into existence. The fair value accounting, on the other hand, will record non-financial assets according to the price prevailing in the market.

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