A historical accounting method is where accounting information is prepared based on past period monetary transactions. It is hardly feasible that what happened in the past will hold on in the future, and so the accounting information may be considered irrelevant on that basis alone. With historical accounting, assets should be recorded at cost, at the purchase price, or the acquisition price. This ignores the effects of inflation on cost as the business keeps the assets over the years. It recognizes that for example a building purchased 40 years ago for $29,000 would be reported today in the statement of financial position at that historical price even though its actual worth today may be $2.9 million.
However, this problem has been overcome by current accounting, which uses asset revaluation. In the case of tangible noncurrent assets such as land buildings and equipment, the current value would be determined by the following formula
NBV= Cost-Accumulated depreciation
Where NBV= Net Book Value
The Net Book Value is the amount of acquisition (production) cost of a non-current tangible asset less depreciation accumulated during its useful life, plus any increases in the value of the asset and less any accumulated impairment losses. The Net Book Value will, therefore, depend on the method of calculation of depreciation used whether it is straight-line depreciation, units-of-production depreciation method, sum-of-years-digits depreciation method, and double-declining balance method.
In the case of current valuation for intangible noncurrent assets, the calculation is dependent on the type of asset. Take a patent that costs $20,000 that is enforceable for 10 years, the legal life of the patent is 10 years the patent shall be amortized by the straight-line depreciation method. The netbook value of the asset shall, therefore, be given by the amortization subtracted from the cost (Walton, 2012).
Current value accounting can cause earning volatility because of the constant shift in depreciation and appreciation of assets as influenced by the market. Since the current value is changing so constantly, it is hard to ascertain the worth of the business entity. Without a definite figure, investors find it difficult to figure out if the business is risky or not. There is also the threat of managers using a current value for earnings management and issues like these can cause significant fluctuation.
Critics of current value accounting have criticized it as being unreliable for reasons such as management of earnings by managers (Gerard, 2009). This can be done by manipulating the fair value of assets and resources to reflect the highest possible value for assets and lowest for liabilities. Managers will value assets when they are in high demand certain and the price to replace them is very high. Liabilities such as debt can be valued when the firm's credit rating goes down such that the fair value of the long-term debt decreases and managers can, therefore, post again (Gerard 2009). Since the costs are quoted at the amount that most benefits managers, there will be no indication of the true value of the company hence current accounting being unreliable.
The requirements given by the SFAS No. 157 affect the use of fair value measurement in financial statements by redefining reasonable earnings, giving a fair value hierarchy used to classify the source of information used in fair value measurements, providing new disclosures of assets and liabilities measured at fair value based on their level in the hierarchy (FASB).
Fasb.org,. (2016). Summary of Statement No. 157. Retrieved 26 February 2016, from HYPERLINK "http://www.fasb.org/summary/stsum157.shtml" http://www.fasb.org/summary/stsum157.shtml
Walton, Peter (2012). The Routledge Companion to Fair Value and Financial Reporting. Routledge Companions.Zack, Gerard (2009). Fair Value Accounting Fraud: New Global Risks and Detection Techniques. Hoboken, N. J: John Wiley & Sons
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