Foundations in Accounting: Fair Value Accounting vs. Historical Cost Accounting

This report analyzes the superiority of Fair Value Accounting (FVA) over Historical Cost Accounting (HCA) for the computation of the value of non-current assets. It discusses the advantages and disadvantages of FVA, its effects on balance sheet, and the IFRS statement of FVA. The report uses Wesfarmers Limited as a case study.

Running head: FOUNDATIONS IN ACCOUNTING
Foundations in Accounting
Name of the Student
Name of the University
Author’s Note

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Table of Contents
Introduction......................................................................................................................................2
IFRS Statement of Fair Value Accounting......................................................................................2
Fair Value vs. Historical Cost Accounting......................................................................................3
Advantages and Disadvantages of Fair Value Accounting.............................................................4
Effects on Balance Sheet.................................................................................................................5
Conclusion.......................................................................................................................................8
References........................................................................................................................................9

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Introduction
The process of Fair Value Accounting (FVA) has been gaining popularity from most of
the accounting standards all over the world for financial reporting. Among them, the
International Financial Reporting Standard (IFRS) has also considered the application of FVA
for the accounting of non-current assets for the Australian Security Exchange (ASX) listed
companies (Zack, 2013). It implies that IFRS has allowed the application of FVA in position of
the use of Historical Cost Accounting (HCA) for the valuation of the non-current assets. It needs
to be mentioned that the main aim of FVA is the development of correct financial statements so
that they can reflect the true financial position of the companies. In this process, difference in
opinion can be seen under the process of FVA and HCA (Christensen & Nikolaev 2013). This
particular report aims at the analysis of the superiority of FVA over HCA for the computation of
the value of non-current assets. Wesfarmers Limited has considered for this report.
IFRS Statement of Fair Value Accounting
The framework of IFRS Framework 13 Fair Value Measurement contains all the
information and details about the factors needed for the successful implementation of fair value
accounting (iasplus.com, 2018). This particular standard puts the accounting obligation on all the
ASX listed companies to use fair value accounting process for measuring the value of their non-
current assets. As per this particular standard, the notion of ‘exit price’ can be used for defining
the aspect of fair value. Under the process of fair value accounting, a market-based measurement
is taken into consideration rather than entity based measurement. Another essential standard in
this aspect is IFRS 5 Non-current Assets Held for Sale and Discontinued Operation as it
provides the direction for the accounting treatment of non-current assets. This particular standard

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states that there is no need to charge depreciation on the assets held for sales and their valuation
needs to be done under the basis of fair value accounting after deducting the selling cost
(iasplus.com, 2018). After that, the accountants are required to present them separately in the
financial statements. Lastly, companies are required to follow all the required standards for
separately disclose them.
Fair Value vs. Historical Cost Accounting
Some specific differences can be seen between FVA and HCA. Accountants consider
FVA as the improved version of HCS as FVA does not have the drawbacks that can be seen in
the accounting of HCA (Blankespoor et al., 2013). The most important aspect under FVA is the
initial price paid while buying any assets or liability. For this reason, these initial prices of assets
and liabilities does not have the ability to fluctuate the price in the balance sheet while this
fluctuation can be occurred in case of HCA. The main reason is the consideration of all the
changes in the price of assets and liabilities by the process of FVA. For this reason, under the
process of FVA, the financial statements of the companies reflect the correct financial position of
the businesses (Shalev, Zhang & Zhang, 2013). The whole fact indicates towards the
consideration of the price volatility of the assets and liabilities while HCA does not do it. Thus,
based on the above discussion, it can be said that the accounting process of FVA has superiority
over HCA for not depending on any subjective valuation of assets.

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Advantages and Disadvantages of Fair Value Accounting
Advantages: The advantages are as follows:
o FVA provides the companies with major assistance in the reduction of assets in the
market. Companies can ensure their survival in weak economy with the help of this
strategy (Barth, M. E., Gómez-Biscarri & Kasznik, 2012).
o In the presence of FVA, companies can get the accurate value of their assets and
liabilities as it takes into account the major increase and decrease in the value of assets
and liabilities. Thus, the investors can know the fair financial position of the companies
(Palea, 2014).
o With the implementation of the accounting of FVA, companies can track the values of
the assets and liabilities where the correct value is not easy to obtain under the accounting
process of HCA. This aspect increases the popularity of FVA (Magnan, Menini &
Parbonetti, 2015).
o Financial managers and the accountants do not get much scope to do manipulation in the
values of assets and liabilities in the presence of FVA as actual value is used for tracking
the sales of these assets and liabilities (Palea, 2014).
Disadvantages: The disadvantages are as follows:
o It is required for the business organizations to get recode of the historical value of the
assets and liabilities for the measurement of accuracy. Under FVA, there is not any
system of recording the historical values and it is a major disadvantage (Cairns, 2012).

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o With the application of FVA, companies allow large fluctuations in the value of assets
and liabilities many times in a year and it is tedious to record all these fluctuations. It can
be considered as a major disadvantage (Bell & Griffin, 2012).
o The investors are not always able to notice the application of FVA in the financial
statements and thus, it creates major dissatisfaction in the investors. They can only seen
the reduction of income of the company (Bougen & Young, 2012).
Hence, the above discussion shows the presence of both advantages and disadvantages in the
application of FVA and all these aspects are required to be taken into consideration.
Effects on Balance Sheet
The financial statements of Wesfarmers is perfect for measuring the superiority of FVA
over HCA as this company can be seen among the top 100 companies under ASX. The following
discussion shows the valuation of non-current assets of Wesfarmers under FVA:
Investments in associates and joint venture is the first non-current assets of Wesfarners
in 2017 Annual Report. It can be noticed in note 18, page 127 that for the measurement and
recognition of this non-current asset, Wesfarmers use their cost value after the addition of post-
acquisition charges (wesfarmers.com.au, 2018). Thus, it can be seen that the company follows

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the IFRS standard of IAS 1(54) (e). It needs to be mentioned that all the changes under this
assets has been considered as per FVA measurement.
Deferred Assets is the next listed non-current asset in the balance sheet of Wesfarmers.
For the calculation of this asset, the company has complied with the IFRS standard of IAS 1 (54)
(o), (56). Compliance with this standard has made the company to recognize and measure the
asset at the date of the development of balance sheet (wesfarmers.com.au, 2018). It implies that
the company recognizes the value of this asset after considering all the necessary changes that is
not done under HCA.
Property is the next listed non- current asset in the balance sheet of Wesfarmers. For this
valuation, the company has compiled with the IFRS standard of IAS 1 (54) (a) as the company
has considered all the necessary aspects like impairment, depreciation, replacement cost and
others while recognizing and measuring this asset. It is a process of FVA (wesfarmers.com.au,
2018).
Plant and Equipment is the next non-current asset in the financial statement of
Wesfarmers. For the valuation of this asset, the company has adopted the same IFRS principle
like above that is IAS 1 (54) (a). It implies that the company has considered all the fluctuations
in the value of this asset while measuring and recognizing and it is a part of FVA accounting
(wesfarmers.com.au, 2018).
Goodwill is the next non-current asset listed in the balance sheet of Wesfarmers. It is
clearly stated in note no. 8 of the financial statements that the company has complied with the
policy of FVA for the valuation of goodwill and the company has complied with the IFRS
standard of IAS 1 (54) (c). In this case also, the company has considered all the changes in the

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value of goodwill. The same valuation system can be seen in case of the next non-current asset of
Wesfarners that is Other Intangible Assets (wesfarmers.com.au, 2018).
The last item under the non-current assets of the balance sheet of Wesfarmers is
Derivatives. It can be seen in the financial note no. 16 that the company has adopted the strategy
of FVA in order to value their derivatives on the date of contracts. In addition, the company also
uses fair value measurement for re-measuring them. It needs to be mentioned that the company
has complied with the IFRS principle of IAS 1 (54) (d) and IFRS7 (8) for the valuation of
financial derivatives. The company also uses FVA for the hedging of these derivatives
(wesfarmers.com.au, 2018).
The values of the assets in the balance sheet and other financial statements have large
effect on the financial health of the companies and the investors use these values in financial
statements for making major investment decisions. These values help in the determination of the
credit worthiness of the business organizations. Thus, it is expected for every business
organizations that their financial statements reflect the correct financial position of their
businesses (Barth, M. E., Gómez-Biscarri & Kasznik, 2012). There is not any exception of this
fact in case of Wesfarmers. From the above discussion, it can be observed that the company
follows the principle and standards of IFRS for the implementation of FVA accounting. It needs
to be mentioned that there would be significant difference in the values of the non-current assets
in case Wesfarmers adopted HCA standards. Under HCA, the financial statements of the
company would fail to convey the correct financial position as it would not take into
consideration all the changes in the value of the assets. As a result of this, it would not be
possible for the financial statements of the company to reflect the correct financial position of the

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company and this aspect would lead to the incorrect decision-making process by the investors
(Palea, 2014).
Conclusion
The above discussion states that it is crucial for the business organizations to select the
correct accounting method for the financial success of them. For this reason, the companies are
required to scrutinize both the advantages and disadvantages of the accounting methods. The
above discussion sheds light in the fact that one can get all the details related with use of FVA
for the companies listed under ASX. The above discussion discusses about both the advantages
and disadvantages of the adoption of FVA. It can be seen from the above discussion that the
prepetition of advantages are more than the disadvantages. From the analysis of the financial
statements of Wesfarmers, it can be observed that the company has complied with the standards
and principles of FVA in order to measure the value of their non-current assets in their different
financial statements. It can also be seen that the adoption of HCA would create significant
impact on the value of the non-current assets. Thus, based on the above discussion, it can be
concluded that companies should permanently replace HCA with FVA for the valuation of non-
current assets.

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References
2017 Annual Report. (2018). Wesfarmers.com.au. Retrieved 30 March 2018, from
https://www.wesfarmers.com.au/docs/default-source/default-document-library/2017-
annual-report.pdf?sfvrsn=0
Barth, M. E., Gómez-Biscarri, J., & Kasznik, R. (2012). Fair value accounting, earnings
management and the use of available-for-sale instruments by bank managers (No. 05/12).
School of Economics and Business Administration, University of Navarra.
Bell, T. B., & Griffin, J. B. (2012). Commentary on auditing high-uncertainty fair value
estimates. Auditing: A Journal of Practice & Theory, 31(1), 147-155.
Blankespoor, E., Linsmeier, T. J., Petroni, K. R., & Shakespeare, C. (2013). Fair value
accounting for financial instruments: Does it improve the association between bank
leverage and credit risk?. The Accounting Review, 88(4), 1143-1177.
Bougen, P. D., & Young, J. J. (2012). Fair value accounting: Simulacra and simulation. Critical
Perspectives on Accounting, 23(4-5), 390-402.
Cairns, D. (2012). The use of fair value in IFRS. In The Routledge Companion to Fair Value and
Financial Reporting(pp. 25-39). Routledge.
Christensen, H. B., & Nikolaev, V. V. (2013). Does fair value accounting for non-financial assets
pass the market test?. Review of Accounting Studies, 18(3), 734-775.
IFRS 13 — Fair Value Measurement. (2018). Iasplus.com. Retrieved 30 March 2018, from
https://www.iasplus.com/en/standards/ifrs/if

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IFRS 5 — Non-current Assets Held for Sale and Discontinued Operations. (2018). Iasplus.com.
Retrieved 30 March 2018, from https://www.iasplus.com/en/standards/ifrs/if
Magnan, M., Menini, A., & Parbonetti, A. (2015). Fair value accounting: information or
confusion for financial markets?. Review of Accounting Studies, 20(1), 559-591.
Palea, V. (2014). Fair value accounting and its usefulness to financial statement users. Journal of
Financial Reporting and Accounting, 12(2), 102-116.
Shalev, R. O. N., Zhang, I. X., & Zhang, Y. (2013). CEO compensation and fair value
accounting: Evidence from purchase price allocation. Journal of Accounting
Research, 51(4), 819-854.
Zack, G. M. (2013). Fair Value Accounting. Financial Statement Fraud: Strategies for Detection
and Investigation, 117-128.