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Revolutionary changes in accounting had raised few issues in the world of Accounting, Business and Economics. One of the major issued which showed are serious part is the issue of movement from Historical Cost measurement system to current market value (Fair Value) measurement system. There are plenty of findings and opinion had been done by some researchers or authors to give their opinion in this issue. Some of them argued that Historical Cost system is better than Fair Value system, some argued Fair Value system is better than Historical System and some feels that it's not important which system is better as long as the information obtain is relevant and reliable to shareholders and investors decision making process. Further in this assignment we will review the literature of research and opinion given by some researchers and authors regarding this issue and we will be using their ideas and findings in analysing the changes occurs in the movement from Historical Cost system to Fair Value system. We will also analyse whether this changes amount to revolution, whether Fair Value measurement system will become the only main measurement system and is the changes happen is desirable for decision makers.
According to journal title 'Usefulness Of CCA Information For Investor Decision Making' which prepared by (Duncan, Keith & Moores, Ken., 1988) for 'Accounting and Business Research', New Zealand Society of Accountants' did a research basically to find more evidence and information related to the negative statement by company Directors about the relevance and reliability of fair value or Current Cost Accounting (CCA) information by implying that such information is not useful to investors if we compared with Historical Cost Accounting information. Along with the statements of Directors of the non-complying companies to New Zealand Society of Accountants' CCA-1 standard, they raised a number of research question which are the basis of this research. In this question they inquire about;
Do decision maker makes different decision or predictions using CCA information compared with Historical Cost information?
If these decisions are different, are the decision based on Historical Cost measurement system is better than CCA measurement system?
If any measurement used in decision making deliver more representative of what it purports to represent?
According to the research done based on the question raised by the directors, an experiment has been held by final year undergraduate accounting student to analyse data provided on two companies for investment decision making and ranking the perceived reliability for the financial statements. From the experiment, there are some findings resulted at the end. Such as;
There are differences in decision making and predictions using CCA measurement system and Historical Cost measurement system.
CCA is 'relevant' in investment making in that it facilitates different and 'better' decisions.
On the basis of evidence it could be stated that CCA statement are more reliable than Historical Cost statement.
From the research done and experiment held, the authors concluded that CCA (Fair Value) information is more relevant. This research and experiment are contrary to Directors' of non-complying companies and their negative statement of Historical Cost is more useful than CCA by refused implementation of CCA-1 standards. So based on the facts and findings New Zealand Society of Accountants CCA-1 standard still became a mandatory reporting requirement.
Referring to a journal titled 'Issues regarding valuation in accounting from historical cost towards fair value' written by (Nichita Mirela Elena,n.a) for 'Academy of Economic Studies in Bucharest' has discussed about the several accounting model that can be used to evaluate the valuation and also it's implication and tools used are historical cost and fair value. IASB mentioned that companies are not proving their real profit by using historical cost in evaluation. Author has discussed that in accounting there are several methods can be used in measuring an object or items. All the measurement used doesn't indicate the exact value carried in balance sheet and income statement. Due to that, author has mentioned that IASB has introduced "fair value" as the measure as it would be able to standardise all the measurements used previously such as historical cost, current cost, realizable value and present value. The introduction of fair value will improve determining the value of each object and items shown in accounting statement according to the current value rather than the purchase value. In conclusion author has concluded that fair value determines the exact performance of a business where the current value will be indicated as it will boast in stakeholders' interest, companies' performance and job creations.
According to another journal title 'HISTORICAL COST VERSUS FAIR VALUE' which prepared by (Cozma Ighian Diana.,n.a) for 'Universitatea de Nord Baia Mare', basically tells us the differents and the purpose of the movement from Historical Cost measurement system to Fair Value(current market value) measurement system. By her opinion, 'the increased important of the concept 'valuation' in the importance of Financial Asset have created the framework for developing a new value based accounting model.' The modification of value-based accounting model consists of reconsidering basic principal of valuation (Historical Cost), allowing accountancy move from Historical Cost measurement valuation system.
The author also reviewed to other few authors' research or journal regarding to Historical Cost and Fair Value measurement system. According to other authors, there are few opinions can be related to Historical Cost and Fair Value. Such as;
Historical Cost and Fair Value has their own strength and weakness. (Deaconu A., 2004).
We have to aware that we are dealing with amended Historical Cost. (Tournier J.C., 2000).
According to (Ristea M., 2003), Historical Cost measurement is widely accepted by accountants due to its objective nature and it's generally easily understandable to its users. However, Fair Value measurement system are inherently subjective because they are based on estimates made by a qualified person who uses only objective data made available to them.
Damodaran A., (2002) explains that 'an asset with current value that differs from its accounting value results accounting principles to place that assets under doubt.' He also refers Fair Value measurement system is often 'considered as too unstable and that is too easy to manipulate which may results as irrelevant estimates for the value of an asset.'
The movement from Historical Cost to Fair Value measurement occurs during the period marked by 'Inflation', when Historical Cost accounting is found not reliable and causes an inaccurate reflection of the real situation. So this effect makes the movement to Fair Value measurement system which will be more suitable in price valuation and re-discussion of financial statement when 'Inflation' hit the economy.
The author concluded that, it is not about which measurement system is the best or better, it's all about which measurement gives relevant and reliable information at the end for investors and shareholders. So the author suggested either 'we use Fair Value along with Historical Cost which some element were evaluated in drafting Financial Statement' or 'we draft Financial Statement which all the elements are reflected at their Fair Value and they come as an additional to the ones expressed in term of Historical Cost.'
The changes or movement from Historical Cost measurement system occurs because some companies feels that the information prepared based on Historical Cost measurement system is not reliable and relevance for decision making process particularly when it is used in evaluating the items in the Financial Statements. 'Companies are aware that their Historical Cost systems do not provide the useful information investors need. Reliance on financial statements has become insufficient for evaluating a company's ability to create future economic value.' (Eve Lamberg., 2003). The implementation of fair Value measurement system is raised because there is increased in importance showed to investors and shareholders benefits. Some critics aware that Historical Cost did not present the actual reflection to the real value of a Financial Statements and results to a preparation of irrelevant or unreliable Financial Statement. So when the shareholders or investors made a decision, it became unsuitable or irrelevant. This situation occurs because of differences in the value of an item presented in the Financial Statement with the real value of the item. According to (Dolphy D'Souza., 2008);
"Companies could inappropriately smooth their profits through the creation of hidden reserves or excessive provisions. The inadequacy of the historical cost, transaction-based approach for dealing, in particular, with derivatives (which have little or no initial cost but can expose companies to very substantial financial risk) and diminutions in the value - impairments - of assets, encouraged standard-setters to espouse an asset/liability approach to recognition and a "fair value" basis of measurement of assets and liabilities."
According to literature reviewed earlier, we know that Historical Cost reflects the real value of an item in financial statement but if there is any changes in the value of the item so Historical Cost will irrelevant to be used to evaluate the items in Financial Statement. This issue is started to look seriously during the period of 'Inflation' in the economy when the value based on Historical Cost in inaccurate reflection compared with the real situation. (Cozma Ighian Diana, n.a) argued that 'inflation accounting systems fail to reveal the actual value created by the company. This system only re-assesses past transactions based on the observed price raise. So that it still uses historical cost, although it is an updated one.' So the 'Inflation' also becomes one of the main reasons for the movement from Historical Cost because implementation of Fair Value measurement system makes an economy easier to determine the changes or variation in the prices and re-discussion of financial statement in the economy which hit by 'Inflation'. This change amounts to a revolution when few opinions and findings had been done in favour to the implementation of Fair Value measurement system. These findings and opinion argued that Historical cost measurement system usually results to unstable and irrelevant value in the financial statements. Among the findings, authors (Dumontier P. & Teller R., 2001) also 'believe that the traditional accounting model is no longer pertinent' and they most often bring the following arguments in support of that:
An increase of immaterial investments, in research and development.
The "itemized", non-recurring elements that affect a company's' results.
The accounting losses accumulated by companies that apply the principle of prudence.
Apart from this, International Accounting Standard Board (IASB) introduced implementation of Fair Value measurement system as a primary measurement basis for Assets and Liabilities items in the preparation of Financial Statement. 'As a result, a substantial portion of a reporting entity's assets and liabilities will be stated in the balance sheet at "fair value" - including pension assets and liabilities, derivative financial instruments, certain other financial assets, financial liabilities held for trading, tangible and intangible fixed assets that have been acquired in a business combination, impaired or revalue, assets held for disposal, share-based payment liabilities, investment properties, provisions and biological assets'. (Nichita Mirela Elena.,n.a). Rather than that International Financial Reporting Standards (IFRS) and International Accounting Standards (IAS) urged the implementation of Fair Value measurement system in several cases in determining values of accounting items. They are;
Expensing share options. (IFRS 2)
Assets acquired in takeover. (IFRS 3)
Surplus assets. (IFRS 5)
Carrying amount on balance sheet. (IAS 16 and 40)
Measurement of lease assets and liabilities. (IAS 17)
Impairment Reviews. (IAS 36)
Measurement of embedded derivatives. (IAS 39; IFRS 7)
Agricultural Assets. (IAS 41)