Advanced Financial Accounting Report: Fair Value vs Historical Cost

This report delves into the core concepts of the IASB framework, focusing on historical cost and fair value accounting methods. It assesses the better option for valuing Property, Plant, and Equipment (PPE) and Intangible assets, comparing the valuation practices of BHP Billiton, A CAP Resources Ltd, and AAR Corp. The report explores the benefits and challenges of both historical cost and fair value accounting, providing insights into their impact on financial statements. It also identifies valuation practices for PPE and intangible assets, examining whether the three companies follow similar approaches. Ultimately, the report analyzes the implications of using either historical cost or fair value accounting for PPE and intangibles, culminating in a comprehensive conclusion.

Advance financial accounting

TABLE OF CONTENTS
Introduction......................................................................................................................................3
Part A...............................................................................................................................................3
Part B...............................................................................................................................................4
Benefits of Historical Cost...........................................................................................................4
Challenges of Historical Cost......................................................................................................5
Benefits of fair Value measurement............................................................................................6
Challenges of fair value...............................................................................................................6
Part 3- Identificantion of valuation Practices..................................................................................7
PPE..............................................................................................................................................7
Intangibles asset...........................................................................................................................8
Assessment of Valuation policy to ascertain whether THE THREE companies have same
valuation practices or not.................................................................................................................9
PPE..............................................................................................................................................9
Intangibles asset.........................................................................................................................10
Historical cost or Fair value accounting for PPE and Intangibles.................................................11
Conclusion.....................................................................................................................................11

INTRODUCTION
The conceptual framework of IASB provides the accounting provisions which underlie the
manner of formation and presentation of financial statements so that appropriate information can
be provided to external users (Cannon and Bedard, 2016). Present report revolves around the
IASB Framework and measurement concepts relating to historical cost and fair value accounting.
The foremost objective of the present report is to assess the better option between fair value
accounting and historical value for PPE and Intangibles. In order to present appropriate analysis
assessment of three companies, i.e. BHP Billiton, A CAP Resources Ltd and AAR Corp has been
made relating to valuation practices followed by them regarding PPE and Intangibles. By
considering annual report of companies comparative evaluation is done to determine whether all
three companies are having same valuation practices or not.
PART A
According to the recent framework of the international accounting standard board, there are
different principles and concepts of accounting. The historical cost of accounting is based on the
thought that liabilities and assets are calculated and reserved as per the original price of
acquisition (Magnan, Menini and Parbonetti, 2015). However, the assets which tend to have an
important change in value over a period of time because of the change in technology and land
will result in improper measurement. In accordance with the IFRS, while measuring historical
costs, the assets are required to assign value in the books of accounts. The cost has clearly
offered measurements that are reliable, verifiable and objective in their results (Glover, Taylor
and Wu, 2016). In the new standard of accounting the convention of historical cost requires the
asset to be recorded at the historical value till it is sensible to identify a value lower than it due to
impairment. The historical cost is not applicable and cannot be measured in various assets like
investments in shares, trade receivables and cash
The cost of asset is a base of measurements of the elements in the financial statements. The
process of measurements is determined on the basis of the financial amount on which the
features of financial statements are identified and are carried in the position statement and profit
and loss account (Yao, Percy and Hu, 2015). There are generally four bases of measurements
such as historical cost, realizable value, present value and current cost. It is used in combination
with another base of estimation. For instance, the inventories are generally considered at lower of

cost and net realizable value, while on the other side securities are considered at market value,
and companies prefer to take pension liabilities at the current value.
In accordance with the IFRS, the fair value is a set of the framework which is used to measure
the value of the assets and also disclose the facts about the measurements of fair value. This
concept is measured when the other model allows the calculation of fair value of the assets. The
IFRS also defines fair value as the amount which will be obtained at the time of selling an asset
or paying for the transferring of the liability (Singh, 2015). The transactions take place among
the participants and the market at the date of measurement. The fair value is measured under a
situation when the company will use assumptions at the time of pricing the liability or asset
under the recent condition of the market (Magnan, Menini and Parbonetti, 2015). This is done
among the market and its participants on account of the level of risk.
Recently the IASB has completed a mutual project with the FASB on the measurement of fair
value system. The outcome of it was the IFRS 13 for fair value measurement. It assumes that all
the transaction of transferring and selling of the assets and liabilities occur in the principal
market and in the absence of this market the process cannot be implemented (Müller, Riedl and
Sellhorn, 2015). The principal market is one having the highest volume and high level of activity
for the liability and asset which can be accessed by the company.
IFRS 13 additionally sets out certain valuation ideas to aid the assurance of fair value. Only for
non-financial resources, fair value is chosen in view of the most elevated and best utilization of
the advantage as dictated by a market member (Laux, 2016). The fair value of an obligation or
the company’s own value accepts that it is exchanged to a market member on the estimation
date. Regularly there is no noticeable market to give estimating data and the most elevated and
best way to utilize. The fair value is then in light of the point of view of a market member who
holds the indistinguishable instrument as an advantage. But if there is no comparing resource, a
valuation strategy is utilized, just like the case with a decommissioning action.
PART B
Benefits of Historical Cost
Firstly the principle of historical cost automatically requires the account of every single
transaction of the past. The market estimation of goods cannot be learned without knowing how
the merchandise was really produced (Watts and Zuo, 2016). But there is no real way to decide

the historical cost of the products without a record of how the items were really delivered and
how the materials and work that added to the generation of the merchandise were really acquired.
In this way, verifiability of money related statements under historical cost is a supporting record
of every single real transaction previously (Magnan, Menini and Parbonetti, 2015). There is no
such confirmation when money related statements are organized under a valuation strategy other
than historical cost.
Secondly, historical cost is fundamental for the best possible working of responsibility, the idea
upon which the modern financial society is manufactured (Basu and Waymire, 2017). Without
historical cost information, a supervisor will have a troublesome time exhibiting that he has
legitimately used the assets endowed to him by the investors.
Thirdly, extraordinary valuation strategies could be reliable regarding their impact on execution
estimation of business undertakings. The imperative issue concerning resource valuation is
whether the economic performance of the company should be calculated on the basis of the
historical cost method.
Challenges of Historical Cost
The financial statements which are prepared in accordance with the historical cost accounting are
basically the statements of facts of history. The modifications in the money value are a result of a
change in the price level of the asset and liability which is not being taken into account (The
Conceptual Framework for Financial Reporting, 2010). Hence, the process gets fails in order to
provide a fair and true status of the issues in the company.
Unrealistic Fixed Assets Values
In accordance with the principle of historical cost accounting, non-current assets are recorded at
the price on which it was purchased. Future changes in the value of the asset are not reflected in
the books of account.
Inadequate provision for Depreciation on asset
Provision of depreciation is made to charge reducing value of asset as an expense over the years
to generate funds for its replacement. In approach of historical cost, depreciation is charged on
the basis of the historical cost of the concerned asset, not at the value on which cited it was

purchased initially. Further; the provision made in the form of depreciation will be charged on
the original cost of the asset and same will not be appropriate for the purpose of replacement of
assets.
Unrealistic Profit
In a situation where income statement is formed by considering accounting principle of
historical cost accounting then it does not show an actual profit of the business. It is because;
business revenues are recorded as per current value while associated expenses are shown at
historical cost (Magnan, Menini and Parbonetti, 2015). Due to this factor; profit of the business
is overstated, and a factor of inflation is not reflected.
Benefits of fair Value measurement
Reduced tax payable
Under the method of fair value accounting, the net income of the company decreases whenever
there is a reduction in the value of the asset. The same happens if there is a rise in liabilities. Net
income represents the bottom line of the income statement of the Company. This is the amount
that reflects the total income tax to be payable by the Company. Thus, this proves as an
advantage for the Company because a low net income will mean low taxes.
Realistic financial statements
The companies which report under this method have financial statements more precise as
compared to the companies which do not use any fair value method. The assets and liabilities are
reflected in their actual value which makes financial statements more accurate (Müller, Riedl and
Sellhorn, 2015). This method requires the companies to disclose any changes made in the
financial report. These disclosures are done by the companies in the form of notes to accounts.
This also makes the evaluation much easier and allows the Company to make wise decisions.
Benefit for investors
The accounting through fair value is beneficial for the investors as well. This is because with fair
value accounting the assets and liabilities reflect the true status of the financial health of the
Company. This makes easier for investors a take wise decision regarding their investment. With

the help of notes to accounts, the investors can evaluate the impact of any changes in the assets
and liabilities.
Challenges of fair value
Frequent changes
Today’s market is highly volatile, and changes in the value of item occur more frequently as
compared to previous times. This results in fluctuations in the earnings of the Company. The
losses are written against the earnings of the Company (Müller, Riedl and Sellhorn, 2015). This
fluctuation in value makes it difficult for investors to judge the financial position of the
Company and hence it makes it a complex situation for Public Limited Companies. Along with
this, the fluctuations also result in audit problems due to incorrect valuations.
Less reliable
Many accountants find fair accounting value less reliable than historical cost valuation. This is
because to find out the fair value; market factors are taken into consideration. Thus similar assets
may reflect different status in different companies. This may result in discrepancy and incorrect
valuations.
Inability to Value specialized assets
Businesses that have special assets consider it problematic to value them on the value prevailing
in the market. This is because of lack of information available for these assets.
PART 3- IDENTIFICATION OF VALUATION PRACTICES
Historical cost accounting and fair value accounting are two valuation methods which are
applied to record assets in books of accounts. Historical cost method evaluates the value of the
original cost of the asset; however fair value method measures the current value of the asset. The
first method ascertains the value of assets through ascertaining the price at which asset was
purchased, and the other method ascertains the market value of the asset in order to ascertain the
value on which asset is required to be recorded in books of accounts (Nicholas, 2014). Presently,
the companies have the choice to follow the most appropriate method of valuation in accordance
with the asset whose valuation is to be done by the company. The valuation practices followed
by the specified three companies have been analyzed below in detail:

PPE
BHP Billiton AIR New Zealand A cap Resources Limited
 The cost of the asset is
the fair value at a time
when the asset was
acquired including the
cost which was
incurred by the
Company for bringing
the plant in working
condition (BHP,
Annual Report 2017).
 The part of the cost of
PPE which is not
capitalized is
categorized as
exploration cost.
 The PPE is recorded
at a cost after
deducting
accumulated
depreciation and
charges of
impairment.
 A regular review is
undertaken to
determine to carry
forward costs of PPE.
The Capitalization
cost is carried forward
to the limit that is
 The company records
Property Plant and
Equipment is recorded
at cost or deemed cost
reduced by
accumulated
depreciation. The
amount attributable to
the acquisition of an
asset and bringing the
asset to location is
also included in the
cost of the asset (Air
New Zealand, Annual
Financial Report,
2017).
 Financial lease asset is
evaluated at an
amount which is
lower of the present
value of lease
payments at the
completion of the
lease or the fair value
of the lease.
Moreover, fair value
is measured on a
reliable basis.
 The company
measures the PPE on
the basis of cost
method after
deducting the amount
of depreciation. The
Carrying amount of
PPE is reviewed on a
regular basis by the
management to ensure
that the book value is
not more than the
recoverable amount
(Annual Report, A-
cap Resources
Limited, 2017).
.

anticipated to be
recovered. If the
Company does not
expects the same to be
recovered.
Figure 1: Notes of BHP Billiton relating to PPE
(Source: BHP, Annual Report, 2017)

Figure 2: Notes to accounts of PPE relating to AIR New Zealand
(Source: Air New Zealand, Annual Financial Report, 2017)
Intangibles asset
BHP Billiton AIR New Zealand A Cap Resources Limited
 The amount paid for
acquiring intangible
assets is capitalized by
the Group. The
intangible assets
include software,
licenses and
acquisition of mineral
assets when it is
 The intangibles are
valued through
capitalized in
accordance with the
cost incurred for
acquisition and bring
to use the asset, i.e.
computer software.
 At the end of
accounting period, the
Group undertakes
regular review
regarding the
recoverable amount
and fair value of their
impairment (Annual
Report, A-cap

anticipated that these
assets will benefit the
Company in future
(BHP, Annual Report
2017). These are
noted at fair value in
the balance sheet after
reducing the
accumulated
amortization.
 The assets are
depreciated on a
straight-line basis over
the useful life, not
more than 8 years.
 The asset has a finite
life and is depreciated
on the straight-line
basis as per the
probable useful life of
three to six years (Air
New Zealand, Annual
Financial Report,
2017).
Resources Limited,
2017).
 The recoverable
amount is the greater
of the fair value of the
asset.
 If the asset’s carrying
value is more than the
recoverable amount,
the expense is
recorded in the P&L
account.
 If the recoverable
amount cannot be
estimated, the Group
estimates the
recoverable amount of
the CGUs to which
the asset belongs
ASSESSMENT OF VALUATION POLICY TO ASCERTAIN WHETHER
THE THREE COMPANIES HAVE SAME VALUATION PRACTICES OR
NOT
PPE
All the Three Companies recognizes Property Plant and Equipment at a cost reduced by
depreciation as well as an impairment loss. Cost is ascertained after considering fair value paid
for the asset at the time of purchasing the asset, and it comprises cost which has been paid for
making the asset used for the objective for which it has been acquired (IFRS, 2018). The
financial statements of the Company revealed that the assets are measured on historical cost in
case appropriate historical cost is available, and the assets whose historical cost is not known are
measured at a fair value like on non-current and financial assets (AACA, IAS 16- property plant

and equipment, 2009). The assets are amortized at cost using effective interest method. The fair
value is determined on the basis of prices of current bid for quoted investments. Thus this policy
indicates that the carrying value of intangible and tangible assets are used to determine the
impairment if the recoverable amount is less than the asset’s carrying value. Thus, all the above
mentioned three companies are consistent with their valuation policy and value their physical
assets according to their convenience. Market conditions play an important role in determining
fair value. The financial statements of BHP Billiton are mostly prepared on the basis of historical
cost except for the financial instruments and other physical assets which are held for sale. After
analyzing the financial statements BHP it can be assessed that in case of lease assets are valued
at lower of the fair value of the leased asset or the present value of the lease (BHP, Annual
Report 2017). The leased equipment is also measured at the end of the year for ascertaining the
estimated present value of minimum lease payments. Thus, the study depicts that valuation
policy of all the three companies differentiate regarding lease asset and for acquired PPE
historical method has been adopted by all the three specified companies. In case of Air New
Zealand, the plant and equipment are treated at deemed cost less accumulated depreciation. This
cost also expenditure that can be directly traced to the asset and also the transfers from equity
and cash flow hedges in case the asset is purchased in foreign currency (Air New Zealand,
Annual Financial Report, 2017). Where the plant and property have the definite useful life, they
are accounted separately.
Intangibles asset
In the case of specified companies have acquired any identifiable intangible asset that each of the
company has accounted the asset on the amount paid for the asset. Thus, it can be assessed that
in case of an acquired intangible asset, companies follow same valuation method. However, in
case of BHP Billiton, the difference between the amount paid for the acquisition and fair value of
relating asset and liabilities is accounted as goodwill. It is the only difference which can be
analyzed in valuation method adopted for goodwill (BHP, Annual Report 2017). The intangible
assets are initially measured at fair value after adding any transaction cost except in cases where
the transaction cost are capable of being separated from the asset; these costs are recognized in
the Profit and loss account (The Conceptual Framework for Financial Reporting, 2010). A Cap
Resources Limited measures the non-monetary items at a fair value of the exchange rate if the
combination is done across geographical borders (Annual Report, A-cap Resources Limited,