Fair value vs. Historical cost - Research Paper Example

(Pita and Gutierrez, 2006) Hence, the fair value of an asset or liability best estimates the market value of an asset or liability. The historical cost is defined as the original monetary value of an asset or liability. (Nikolai, Bazley and Jones, 2009) The accounting procedure that pertains to the use of the historical costs includes the use of the original prices of the assets and liabilities. (Plantin, Sapra and Shin, 2004)This means that the prices at which the assets are bought or sold, and the liabilities are incurred and settled are used in the historical costs method of accounting.

Thus, it implies that the value changes (gains or losses) are not considered by companies when using historical costs until an exchange takes place. From 1973 to 2000, there has been an issuance of the International Accounting standards by the IASC. The IASC was replaced by the IASB in 2001 and since then has tried to replace some of the IASs to International Financial Reporting Standards. (IAS Plus: Summaries of IFRSs and IASs) IAS 40 is one example as it moves from the revaluation model to either the fair value or the cost model on the adoption of IFRS.

According to IAS 40, investment property is defined as the property that is held by a person for the purpose of earnings rentals, capital appreciation or both. Under the fair value model, the investment property is the property that can be exchanged between willing and knowledgeable parties in an arm’s length transaction. Gains and the losses that occur in the fair value must be added or subtracted respectively from the net profits in the time period in which the changes take place. Under the cost model, however, the investment property is accounted for (as set out in IAS 16) by measuring cost less accumulated depreciation and less accumulated impairment losses.

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