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Research topic: Historical cost versus fair value accounting for non-financial assets (Word limit: 3000 words)
The choice between fair value and historical cost accounting has been a widely debated issue in the accounting literature (Christensen & Nikolaev, 2013). However, the conceptual framework for international financial reporting (hereafter the IASB Framework) and the equivalent AASB Framework does not prescribe a specific measurement base to account for the key elements in financial reports (the IASB Framework 2010). Specific measurement methods for different accounting elements are provided in the specific international financial reporting standards (IFRS). Unlike most other accounting standards, IFRS provides a free choice between fair value and historical cost accounting for the non-financial asset groups: property, plant and equipment (PPE) (see IAS 16) and intangibles (see IAS 38). This has resulted in variations in valuation practices for PPE and intangible assets.
- Refer to the current IASB Framework and IFRS 13 Fair Value measurements, briefly explain the measurement concepts in relation to historical cost and fair value accounting. 2. Evaluate the benefits and challenges of using historical cost and fair value accounting for PPE and intangibles, by reviewing accounting literature.
- Identify valuation practices (in relation to the use of historical cost and fair value accounting) for the following non-financial asset groups: PPE and intangibles, by reading the 'accounting policy' sections of three listed companies' 2014 annual reports.
Note: You are required to select one company listed London stock exchange, one company listed on the New York Stock Exchange, USA, and the third one is selected from the Australian Securities Exchange.
- Analyse if the valuation practices for PPE and intangibles are consistent across the three companies.
- What is your opinion on the free choice between historical cost and fair value accounting for PPE and intangibles: should such free choice be continued in practice? Or should it be abandoned? Justify your answer.
In Historical Cost Accounting (HCA), the value of an asset is recorded at the original purchase price whereas in Fair Value Accounting (FVA) the value of an asset is updated regularly in line with the current price of similar assets (Greenberg et al. 2013). The first section of this essay discusses the measurement concepts adopted in historical cost accounting (HCA) and fair value accounting (FCA). This is followed by the analysis of the benefits and challenges of these models. Three companies are identified for the evaluation of their annual reports to determine the accounting practices adopted for recording property, plant and equipment (PPE) and intangible assets. The final section includes a discussion on the free choice allowed by accounting regulatory bodies like IFRS and the first preference for a viable model.
Comparison of Historical Cost Accounting and Fair Value Accounting Practices
Historical costs are incurred for transactions related to asset acquisition or construction, thereby making it an entity-specific cost (IFRS 2016). It is the total costs incurred at the time of acquisition or construction and does not include the interpretation of price changes during the process inclusive of consideration and transaction costs.
If historical cost is used to measure the acquisition or incurrence of a similar asset or liability during a different time period, different amounts will be recorded in the financial statement. It is widely viewed that such a measurement minimises the comparability of values within the reporting organisation or with other reporting organisations (IFRS 2016). Despite these issues, measuring similar assets and liabilities through historical cost accounting offers detailed data related to the impact of the difference in duration and the methods of acquiring an asset or incurring liabilities on the profitability of an organisation. This detail offers asset or liability specific and time-specific information which is relevant for users during decision making. Some of the assets measured using historical cost are unimpaired land, indefinite life intangibles and inventories (IFRS 2012a).
Historical cost considers only the actual cost and ignores the probable cost at which an asset would be sold in the open market. It is reflected in the balance sheet as at purchase cost negating any depreciation cost. If the asset is sold, it is reflected in the accounting statement as a profit or loss as against the actual purchase cost with the reduction for depreciation.