Evaluation of Assets: Historical Cost vs Fair Value Method

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ASSESSMNET Question:

Answer to Q.No.1
This argument was found in the page No. 171 of the Book, Financial Accounting
Theory by Craig Deegan 2014 related to evaluation of assets by historical cost
method and fair value method (refer to Chambers, 1966). It was argued that
evaluation of assets by historical cost method may lose its relevance during the
period of rising prices. The question raised on this issue was if the financial
instruments priced in erstwhile value do not prove to be useful for evaluating the
same in respect of its current market value or replacement cost. Moreover, if the
current value of any asset is increased comparing to the cost of acquisition during
that period when it is acquired, there is real practical problem to add to the cost of
that asset.
For the purpose of evaluating non-current assets, many countries follow the
hypothesis of revaluing them as per present market value. There are other factors
like the time of acquisition of those assets, the changing value of the local
currency, etc. Valuation of assets is mainly required to feature in the balance sheet
or consolidated financial position of any business entity to derive its net worth. It
is also argued that evaluation process of assets by historical cost method may
conclude to overstating of profit during the time of rising prices. This profit would
automatically be distributed among the shareholders and would lead to erosion of
operating capacity. (Deegan, 2014)
To explain the statement made by Deegan in his book, highlighting the
observation of adopting historical cost method for evaluation of financial
information, it is observed that this system has shortcomings in case of rising
prices of the financial instruments. This observation is supported by the logic of
inflation affected countries, where prices change very often. In this case, if
historical cost method is followed, it will not feature true value of accounting
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information. This situation may cause for inflated profit with subsequent
distribution to the shareholders and erosion of profit would occur to make the
financial statements unjustified. In this context, other stakeholders might be
affected through the fabricated presentation of financial statements. (Brown,
2017)
There are two types of evaluation method for assets- Historical Cost Method and
Fair Value method. To compare the applicability in regard to authenticity, both
prove vulnerable with their merits and demerits. It is the duty of the policymakers
about mitigating the systemic risk for valuation of assets in financial reports. The
international bodies of accounting guidance, IASB has to play prudent role in this
regard to ensure provision of better logical valuation method for the assets of the
business entities to safeguard the interest of the stakeholders. There is a prolonged
debate about the better option of these two; hence the application of them should
be clearly defined by the accounting policymakers with the regulation under
International Financial Reporting Standards. Right from 2005, this body is
engaged in the modification of fair value method in their policies for application.
It is a never ending effort with the required level of amendments to be
implemented to ensure that fair value method would prove its authenticity with
long term sustainability. Basic objective of the policymakers is to mitigate
systemic risk in the financial reporting globally. This objective can be
accomplished by considering the practical concerns of applying fair value
accounting.
Refer to the discussion in the report Fair Value Accounting, Historical Cost
Accounting and Systemic risk by Greenberg,et al (2013), the conclusion is based
on the review of the authors, which observed that both Historical Cost accounting
and Fair value accounting can be able to discharge practical information, at the
same time, they may also be responsible for vulnerable outcome in the form of
misstatement, if those systems are not applied with rigorous effort to ensure
prudence, diligence and strict guideline. To generate high level financial
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information with good quality, both systems demand good support of governance,
diligent application of theories followed by managerial control of the entities.
This process is to be followed by strong self-regulating audit. In case of absence
of those factors, both the systems can produce poor quality of accounting
information with the negative contribution of both the systems resulting to
generation of systemic risk of the entities. To ensure more prudent financial
reporting to mitigate systemic risk, the policymakers should insist on regular
assessment of the accounting standards with the logical problems coming up
followed by subsequent solutions to resolve those. Both systems are good,
provided they are applied with clear and prudent instinct. (Greenberg D, 2013)
Answer to Q. No. 2
To understand the statement made by Deegan 2014 in his book Financial
Accounting Theory (p. 258) regarding the role of conceptual framework to
enhance public standing of accounting professional, we have to discuss the basic
of conceptual framework and the role of accounting professional to implement
that in financial reporting.
Conceptual framework is also known as concept statement. This framework is
interconnected with specific objectives based on accounting fundamentals. The
objectives are meant for identification of goals and reason for proper reporting of
financial information based on the platform of basic accounting fundamentals to
accomplish those objectives. Those referred concepts are responsible for
providing guidance to ensure selection of transactions, circumstances and events
to be considered along with the system of their recognition and measurement
followed by summarization and reporting. (FASB, n.d)
Accounting professionals take care of preparation of financial statement by proper
analysis of the nature of financial information. Their job is completed with the
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