Accounting for values (35 marks, 300 words) XYZ Company bought real estate properties in Boston 50 years ago for $30,000

Ans:

Historical Accounting Principle.

Under historical accounting principle, asset and liabilities on the balance sheet is reported at its original price as initially transacted by the business. The present market condition and value of such asset and liabilities whatsoever will not consider under this method. The advantage of this method is that the original transaction price is known to us at any given time. Under US GAAP this method is widely used.

Fair Value Accounting Principle

Under Fair value accounting principle, the assets and liabilities recorded at their current market value. The fair value is the amount that the asset could be sold at present, or a liability value could be settled at present. This method gives the picture of the exact position of assets and liabilities of the business at a given time.

Difference between Historical Accounting Principle & Fair Value Accounting Principle

1. Historical accounting is based on the initial transaction cost of the assets or liabilities concerned where as under fair value accounting principle current market price of the item is considered.

2. Under Historical accounting users of financial reports can easily understand the initial transaction price at any time whereas under fair value accounting fair value has to be calculated or assessed by professionals periodically.

3. Under historical accounting depreciation is calculated based on initial transaction price whereas under fair value impairment is calculated based on fair value basis.

4. Historical cost calculation is easy whereas fair value calculation is highly complex in nature and needs professional help.

5. Historical cost is based on actuals where as fair value calculation is based on various assumptions.

6. Fair value method is deemed superior when compared to historical method as fair value method as it reflects the present situation in the market.

Present example of XYS Company

In our question XYS Company brought an asset 50 years ago for $ 30,000. As per historical method of accounting after passing 50 years also the value will be $30000 which has no relation with the present market situations. It is not the exact picture of the company’s actual financial strength. And no investor will sell this estate property for $ 30,000. Under fair value method the value valued as $ 2 million which is a fair value to believe.

Conclusion

Historical value method has no relation with the current market situation which has no meaning at all. Fair value method gives a genuine and real picture of assets with relevance to the present market situation is more viable and trustable to follow. Considering the above facts I completely agree with the new finance manager to the use of fair value accounting principle for the accounting.