Historical Cost versus Fair Value Accounting for Non-Financial Assets - Case Study Example

HISTORICAL COST VERSUS FAIR VALUE ACCOUNTING FOR NON-FINANCIAL ASSETS by Student’s Name Code + Course Name Professor’s Name University Cite, State Date Fair Value Measurement Concepts The IFRS is ascertained to apply to numerous aspects that permit fair value measurements and disclosures about the aspect of fair values measurements like in the case where fair value lessened to costs incurred in selling, as related to fair value or disclosures in relation to those measurements except in certain specified situations (IASB Framework, N.d). The requirement sets out fair value as being the immediate price level that an entity will receive after selling an asset or pay in order to prompt the transfer of a given liability in an organised transaction between market sellers at the immediate measurement date (IASB Framework, N.d). In the course of measuring fair values, a firm adopts the assumption that market participants will only use present current market situations whenever coming up with a price (IASB Framework, N.d). They also adopt risks about risks involved while ascertaining market conditions. The IFRS establishes that fair value measurement permits a firm to establish the following conditions; the distinctive asset or liability that is being measured, for any non-financial asset, the higher and perfect utilisation of the asset and ascertains whether the underlying asset is utilised together with other assets or on a stand-alone, the exact market under which an organised transaction will be conducted for the asset or liability and, the necessary value approaches that will be utilised whenever measuring fair values (IASB Framework, N,d). Notably, fair value accounting is directly concerned with the reporting of assets and liabilities on the statement of financial position or balance sheet at their respective fair values and thereafter, goes ahead to recognise the gains and losses in fair values within the incomes statement (IASB Framework, N, d). Historical Cost Measurement Concept Historical cost accounting is solely based on the stability of a unit assumption. The approach, unlike the fair value measurement does not rely on changes on market conditions hence assets and liabilities are portrayed at their immediate historical costs as if there had been no alterations that were made to their respective values since acquisition (IASB Framework, N,d). Following this case, the balance sheet values of the items will most likely be different from their real values. While most entities overrule the adoption of historical costing due to its perceived inaccuracy, it still gets way into most accounting systems in the course of low and high levels of inflation and deflation periods. In the event that the economic environment changes to a hyperinflation, the IFRS, under IFRS 29, requires entities to measure and disclose financial capital maintenance units of unchanged purchasing power in relation to the monthly CPI (IASB Framework, N.d). Notwithstanding, numerous corrections attributed to historical costs are employed, most them requiring the adoption of management judgements and thus, it might pose a challenge to verify them. In fact, while fair value measurements are employed to ascertain the real values of assets and liabilities in regards to the underlying market conditions, historical cost will still be used certainly to measure assets of little or no significance (IASB Framework, N.d). Benefits and Challenges of Using Historical Cost and Fair Value Accounting For PPE and Intangibles IAS 16 Property, Plant and Equipment, portrays the accounting treatments for a substantial number of PPE. It states that PPE should be initially measured at their initial costs and thereafter, measured using a cost or revaluation technique and depreciation conducted in order to allow the depreciable amount to be allocated on a systematic basis over its underlying useful period (Missonier-Piera, F, 2007). On the other hand, IAS 38 Intangible Assets, establishes the immediate accounting postulations for all intangible assets that are mostly non-monetary assets and do not possess any physical substance and identifiable (Missonier-Piera, F, 2007). Under this requirement, their respective recognition are measured at their immediate costs and thereafter, measured at their costs using a revaluation model (Missonier-Piera, F, 2007). The requirement also demands that they are armotised on a given systematic basis over their given useful lives unless these asset class have an indefinite useful life; a case for which amortisation is not allowed. On the contrary, under the historical cost accounting, property, plant and equipment is recognised and measured at their costs (Power, 2010). Costs related to purchase prices, which are inclusive of import duties as well as other non- refundable purchase taxes and any given level of costs that are directly related to transferring the assets to the company location as well as situations deemed necessary deemed appropriate for distinctive operations (Missonier-Piera, F, 2007). Unlike in US GAAP where intangible assets are measured and recognised at their respective historical costs less any possible accumulated amortisation and impairments and no need for revaluation is allowed, for IFRS they are measured at their respective historical costs less any given level of accumulated amortisation and impairments and are definitely pursuant to an underlying revaluation model (Missonier-Piera, F, 2007). Benefits of HCA and FVA Fair values are deemed to be relevant in measuring and recognising PPE and intangible assets because they depicts an existing economic situations that relate to economic resources and obligations (Barlev & Haddad, 2003). They are a faithful representation of both assets and liabilities since the depict risks as well as probability-weighted evaluations of future expected cash flows. FVA provides neutral, unbiased and easily comparable values in relation to attributes of the asset or liability as opposed to entity’s characteristics (Barlev & Haddad, 2003). On the other hand, whenever employing historical cost accounting to recognise and measure items facilitates a straightforward approach (Barlev & Haddad, 2003). Subsequently, it does not offer a provision for recording possible gains till a period when they are actually realised. Challenges of Using FVA and HCA The challenges of adopting fair value accounting treatment for PPEs and intangible assets does not provide a room for effective verification while the management are allowed room for manipulation of fair value estimates to conform to their interests (Barlev & Haddad, 2003). On the contrary, historical cost accounting provides little or no indication of present values of underlying PPEs of a company (Barlev & Haddad, 2003). Subsequently, whenever applying it to measure and recognise PPEs it fails to account for any possible losses of real values related to nominal monetary items due to possible changes in inflation and deflation (Barlev & Haddad, 2003). Company Valuation Techniques: PPEs and Intangible Assets Wal-Mart The company’s registered symbol in the NYSE is WMT. Wal-Mart is engaged in retailing industry across the globe. The company states PPE at their respective costs. Any possible gains and dispositions made are later recognised as having been earned or incurred (Wal-Mart, 2014). In essence, costs related to fundamental improvements are thereby capitalised while costs attributed to normal repairs as well as maintenance are effectively charged to expense as incurred. Estimates of PPEs useful lives are employed for depreciation purposes using a straight-line approach. Consequently, the entity recognises and measures acquired intangible assets at their immediate fair values as it has been determined using a valuation model that fairly compares to the relative use of these assets (Wal-Mart, 2014). Burson Group Limited The company is a fairly know distributor of automotive, accessories as well as workshop items in the Australian market. It is listed in the Australian Stock Exchange under the symbol name: BAP. The firm states the PPE at their respective historical costs less any possible depreciation. The accounting policy notes that the historical costs also include all expenditures that are directly linked to the acquisition of all items (Burson Group Limited, 2014). Notwithstanding, costs might also involve transfers from equity of any possible gains or losses on a qualified cash flow hedges. In consequent, the costs are also included in the asset’s carrying amounts or in other cases recognised as a separate asset whenever it is deemed necessary and when there is certainty of future economic benefits attributed with the items flow to the Group and measured in exact terms. Possible repairs and maintenance costs attributed to PPE are immediately charged to the income statement in the reporting period (Burson Group Limited, 2014). In regards to intangible assets, the entity measures goodwill in relation to the excess of acquisition related costs over possible fair values of all identifiable assets. In fact, it is carried at their respective costs less possible accumulation of impairment losses (Burson Group Limited, 2014). Subsequent gains and losses on the disposal of a given entity involve all carrying amounts of goodwill that relate to the sold firm. Amortisation of intangible assets is computed using straight-line approach in order to apportion costs related to software over their immediate useful lives (Burson Group Limited, 2014). Barratt Developments Plc It is a company that operates a substantial residential property development firm’s within the United Kingdom. It is listed in the London Stock Exchange under the symbol: BDEV. For this entity, property, plant and equipment are measured and recognised at costs less any possible accumulation of impaired losses. Depreciation is conducted using a straight-line approach to any residual values over expected useful lives (Barratt, 2014). In essence, both residual values and asset lives are evaluated and reviewed on an annual basis. The intangible assets like brands are developed internally but are not subjected to capitalisation except those which have been acquired. The entity conducts an annual review of impairment of all indefinite life brands (Barratt, 2014). This is made possible using a value-in use calculation on pre-tax weighted average costs of capital. Consistency of Valuation Techniques Adopted After taking a closer look at the entities immediate adoption of valuation practices relating to PPE and intangibles, it can be fairly ascertained that all of them have adopted a similar accounting practice. All PPEs and intangibles are measured at their costs but are later armotised and capitalised for review purposes. Review process takes place on annual basis in order to conform to the ever-changing economic situations. Consequently, these entities recognise and measures acquired intangible assets at their immediate fair values as it has been determined using a valuation model that fairly compares to the relative use of these assets. Personal Opinion on Free Choice In my opinion, I do think that a free choice should be allowed for all entities to adopt any of the measurement approaches. My line of argument emanates from the fact that although companies are allowed to choose whether to adopt historical cost or fair value accounting in the end they end up reviewing recorded costs attributed to PPE and intangible assets (Christensen, Hans & Nikolaev, Valeri, 2013). Thus, it means that the review process, which is conducted on annual basis, equalises the cost to the current market conditions. References List AASB Framework, N, d. AASB 116, AASB 138, AASB 13, retrieved from http://www.aasb.gov.au Barlev, B. & Haddad, J.R. 2003. ‘Fair Value Accounting and the Management of the Firm’, Critical Perspectives on Accounting, vol.14, pp.383–415. Barratt. 2014. Annual reports. Retrieved on April 28, 2015 from http://www.barrattdevelopments.co.uk/barratt/uploads/results/Barratt-ar14-full-annual-report.pdf Burson Group Limited. 2014. Annual report. http://www.asx.com.au/asxpdf/20140926/pdf/42sgmdzsdl8l1c.pdf Christensen, Hans B. & Nikolaev, Valeri V. 2013. Does fair value accounting for non-financial assets pass the market test? Review of Accounting Studies, vol.18, no.3, pp.734-775. IASB Framework, N, d. IAS 16, IAS 38, IFRS 13, retrieved from http://www.ifrs.org Missonier-Piera, F.2007. Motives for fixed-asset revaluation: An empirical analysis with Swiss data, The International Journal of Accounting, vol.4, no.2, pp.186–205. Power, M. 2010. ‘Fair value accounting, financial economics and the transformation of reliability’, Accounting and Business Research, vol. 40. no. 3, pp.197-210 Wal-Mart. 2014. Annual reports. Retrieved on April 28, 2015http://cdn.corporate.walmart.com/66/e5/9ff9a87445949173fde56316ac5f/2014-annual-report.pdf Read More