This essay discusses current value accounting and historical cost accounting comparing and contrasting both measurement bases. This essay will be using different examples from companies and international accounting standards to back up the arguments that will be constructed for both measurement bases. Historical cost means what an asset cost when first bought. Current value accounting is the market value of an asset currently disregarding the original cost of the asset.
Historical cost will be the price of the assets and liabilities at the time of the transaction. Advantages of historical cost is that it is faithfully represented and verifiable as it will be stated on the invoice when an asset is bought. The IASB conceptual framework states that (IASB, 2018) historical cost will be much simpler and better to understand as it is verifiable. However, the disadvantage of historical cost is that when measuring impairment losses, it can often lead to subjectivity and will be difficult to verify as a value. Furthermore, another disadvantage of historical cost is that it will not reflect change in value as a result this will reduce comparability. On the other hand, fair value accounting as stated in the framework can prove predictive value of the assets which can help the business decide how much they can sell their assets for in the future to make profits within the business. Historical costs will not provide this as it becomes outdated and may lack relevance in the future.
Fair value accounting will be an estimation of the value of the assets and the liabilities in a company and will be used by a company to consolidate their financial statements. The benefits of fair value accounting are that it will be relevant to the current time as it will provide what the value of the asset is now. However as debated in this journal (Journals.sagepub.com, 2018) !!!!! the drawbacks of fair value accounting are that current value will lack reliability in this case and will be hard to distinguish between nwn1them. Also, there is chance of subjectivity when estimating the values of assets as a business may overvalue their assets to present a more positive picture of the business and even inflate profits.
A company that prepares their financial statements using the historical cost convention is Dixons Carphone (Dixonscarphone, 2018). They have been prepared this way to increase verifiability of the company’s assets will also show that the assets are not for sale. They have applied this convention in accordance with the FRS 101 standard (Frc, 2018) where they permit investments to be measured using historical accounting rules. Ultimately, Dixons Carphone uses historical cost over fair value to verify their costs of their assets and provide a faithful representation of the original cost of the assets bought. That will allow them to see their companies’ previous decisions through their transactions which can help when making future decisions which will affect their business.
Sony in their Annual Report for 2018 (Sony.net, 2018) use fair value measurement for their assets and liabilities when there quoted market prices for their assets are not available. They use fair value measurement to estimate values using their price models. They also used the fair value measurement to effectively predict their future cash flow as a business. They have based their accounts international framework of the United States of America (Na.theiia.org, 2013). The COSO framework states that their main objectives are that their report should reflect the current time of the market. It should be reliable and faithfully reflect the current market state. Therefore, Sony must ensure that their financial reports are reliable and are done in a timely manner to ensure they give them themselves time to make important business decisions. Furthermore, by using fair value measurement Sony is able to predict how their business will do in the future and can plan accordingly to ensure that they continue to increase their profits.
Hoogervorst (2015) states that historical cost should be used when a company will use their assets that they currently have in combination with their others assets they have to produce goods and services then historical cost should be used. However if a business intends to trade their assets and liabilities that they currently have a hold of then fair value will be the measurement that is most suitable. Furthermore, he explains that when considering what measurement bases to use you must consider will it faithfully represent the statements of the business to give a clear understanding to the shareholders and managers of the business of the financial status of the company. Overall, he explains that both fair value and historical cost can be equally relevant when presenting statements which is why companies will use both measurements when consolidating their financial statements. This ensures their statements are relevant and faithfully represented.
An example of a company following what Hoogervorst implies with companies need to use a mixed measurement bases is Morrison’s. They use historical cost convention to prepare (Morrisons-corporate.com, 2018) their financial statements as it will help them have comparability which will help Morrisons evaluate what the trends of their assets are and be able to have a clear idea of their financial performance over time. On the other hand, they have used fair value accounting for their equity instruments as they will be held for long term investments. That will mean fair value is more reliable as if they used historical cost it would lead to the cost being out of date as they need to know what the value is for the long term so it will cause a positive investment for Morrisons.
US GAAP states (Iasplus.com, 2018) that if any asset or liability that the business has the transaction price and the fair value will be recognised as a gain or loss for the business which will be recognised as earning in the statements. A business that adheres to the accounting principles from the US GAAP is Microsoft (Microsoft.com, 2017). They account for their assets and liabilities using the fair value as their valuation technique this allows them to project their cash flows for their future and therefore have an accurate valuation and faithfully represent their assets and liabilities.
The journal on the role of fair value accounting states that (Bolívar and Galera, 2012) that when creating financial reports for a business they need to ensure they consider qualitative characteristics. These are comparability and timeliness which is important as the reports have to be easy to understand so when a manager reads their financial report they clearly have an idea on the businesses financial status. It will also need to make sure they can compare their financial reports as the fair value of their assets should help them be able to compare values of their different assets in their financial statements. It also argues that if the historical cost measurement was used then it will cause the business to have unrelated values;the assets recorded will have different values from different times which will not be as relevant.
In summary, a business should use a mixed measurement system as even though both fair value and historical cost have its downfalls using them both will be more helpful to a business. For example, Morrison uses historical cost to provide comparability for their assets which will allow them to see what their previous financial decisions where and be able to compare what their assets were bought for and provide them with information that will allow them to know what to do to improve their assets in the future. Fair value will not provide however historical cost will be outdated in the future and that is where fair value will be more useful as it will help provide a predictive value of the businesses assets and will allow the business to see what their assets will go for in the future and will also provide a more realistic and relevant financial statement which the business can use to help them predict their future cash flows and have an accurate valuation of their assets. Mixed measurement is the best measurement bases to use as fair value will not help when looking at previous financial decisions whereas historical cost will. Historical cost will not help when looking at the future as it will become outdated whereas fair value will be helpful in the future. Therefore, both measurement bases complement each other. In conclusion, it will be more useful to a business to have a mixed measurement bases as it will help them evaluate previous financial decisions and faithfully represent that in their income statements and balance sheets also by having a fair value measurement for their equity instruments for investments will help them see what their predictive value will be to allow the business to have relevant market information that is not outdated.