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Trade Off Between Fair Value Accounting and Historical Cost Accounting

In: Business and Management

Submitted By huan
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3. Trade off between fair value accounting and historical cost accounting
a) Relevance: Financial information is relevant when it influences the economic decisions of users, Fair value reporting is more relevant as it will allow users of financial statements to obtain a truer and fairer view of the company's real financial situation since it reflects the prevailing economic conditions and the changes in them. In contrast, historical cost accounting shows the conditions that existed when the transaction took place and any possible changes in the price do not appear until the asset is realized.
b) Reliability: This relates to the degree of assurance capable of being obtained through verification that information faithfully represents what it purports to represent. Historical cost is considered more reliable as fair value requires estimations. FASB has expand the disclosures and framework for all companies to enhance the reliability of fair value accounting. However the drawbacks of the FV accounting is still holds as many of the valuations incorporates many subjective input data and assumptions.
c) Decision usefulness: In general, financial information is considered to be useful if it enhances one's ability to make investment and credit decisions.
(i) For investors: Investors will need to broaden their knowledge of fair value measurement methodologies to effectively analyze a company's financial statements and make a sound comparison. Given that institutions may use different models with different assumptions, the fair value of the instruments may not be comparable. Moreover, financial users are accustomed to the historical model and have developed techniques that use the historical cost information to assess the company's financial situation and estimate future cash flows. (ii) For owners: If the fair value method is applied, there would be increase in volatility

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