Is cost accounting more appropriate than fair value accounting for Intangible assets? Essay

In recent old ages, there has been uninterrupted treatment done globally about the accounting methods that should be used for fiscal coverage. Traditionally, historical cost accounting method has been applied to fiscal statements widely. However, an increasing figure of international criterions are leting or necessitating the usage of alternate accounting method, such as just value accounting, for fiscal describing these yearss. That is to state, the tendency for the pick of accounting method is altering from “traditional” historical cost accounting to “newly introduced” just value accounting.

Jaijairam ( 2013 ) emphasizes that it is really of import to understand the advantages and disadvantages of traditional and alternate accounting method – historical cost and just value accounting – and make up one’s mind which 1 would be the appropriate accounting method to be applied to fiscal statements. Because a firm’s pick of accounting intervention for assorted assets can hold a important impact on its fiscal coverage, direction determination, and firm’s hereafter public presentation. Either to take historical cost or just value accounting for fiscal coverage can act upon how companies value their assets, including intangible assets.

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Intangible assets have become progressively of import elements of success in corporate activities. Talha ( 2004 ) emphasizes that for most companies, intangible assets represent both indispensable factors in their advancement and a considerable portion of their corporate value. Besides, the rating of intangible assets is a affair of great involvement to directors, investors and companies. Therefore, it is of import for many parties to understand how historical cost and just value accounting are applied to fiscal statement and how to gauge the value of intangible assets in different ways.

Since historical cost vs. just value has been debated globally, CICA Handbook Part 1 is suited to depict this subject in respects of CICA Handbook. Harmonizing to the enchiridion, “ International finance describing standard 1 that has been adopted by the accounting criterions board. Newly issued, amended or revised international fiscal coverage criterions are portion of Canadian GAAP merely after they are approved by the accounting criterions board in conformity with its due procedure ” .

That is to state, historical cost accounting had been chiefly used worldwide, but just value accounting has been adopted and recognized as freshly and utile accounting criterion ( CICA Handbook, 2014 ) . This paper will discourse the definition of historical cost and just value accounting, pros and cons of both accounting methods, and the decision whether historical cost is more appropriate accounting method for intangible assets in fiscal statements. Discussion What are historical cost and just value accounting?

Before discoursing pros and cons of both accounting methods, it is of import to understand how these two methods are defined. First, historical cost accounting–often considered as one of the most basic rules of fiscal accounting – is the accounting method that requires most assets and liabilities of a concern be accounted for on the footing of their original acquisition cost ( Powers, 1991 ) . Harmonizing to Jaijairam ( 2013 ) , under historical accounting, the initial monetary value paid by the company during the purchase of the plus or incurrence of the liability is the 1 that matters.

Thus, historical cost accounting reflects the existent value of points at the day of the month of their come ining the company ( Diana, 2009 ) . Second, just value accounting, besides called “mark-to-market” accounting, refers to the accounting criterion of delegating a value to a place held in a fiscal instrument based on the current just market monetary value for the instrument or similar instruments. This accounting method is defined as the act of entering the monetary value or value of assets or liabilities to reflect its current market value instead than its book value ( Wagner ; A ; Garner, 2010 ) .

Jaijairam ( 2013 ) besides defines just value accounting as the pattern of declaring the value of the assets or liabilities and helps companies to reset the monetary values of certain assets on its balance sheet every one-fourth to reflect alterations in the market monetary value. Intangible Assetss and Evaluation Since this paper is specific to intangible assets, it is necessary to understand the definition of intangible assets and how the value of these assets is calculated.

Harmonizing to IFRS, an intangible plus is defined as an identifiable non-monetary plus without physical substance and must originate from contractual or other legal rights or be dissociable. Goodwill, right of first publications, hallmarks, trade name names, franchises, patent and Intellectual capitals are good illustrations of intangible assets ( Quilligan, 2006 ) . There are the few rating methods of intangible assets such as market-based, cost-based, use value, investing value, proprietor value, insurable value, and indirect value methods ( Reilly, 2011 ) .

Among these methods, market-based method and cost-based methods are normally used. First, market-based method values intangible assets by mention to minutess or benchmarks of comparable assets that occurred in a similar market late. This method provides the best grounds of just values that relies on existent market minutess. However, it is of import to see that it may be hard to guarantee that the plus under consideration and the market dealing are sufficiently comparable ( Quilligan, 2006 ) .

Talha ( 2004 ) besides states that this method is hard plenty because it is ne’er possible to happen a dealing that is precisely comparable. Talha emphasizes that the hunt for a comparable market dealing is about ineffectual because of different negociating accomplishments with different buyers in the market and the distorting effects of the extremums of economic rhythms. Second, cost-based method values intangible assets by measuring the development or replacing cost of the plus.

This method is frequently used for measuring internally developed assets such as package ( Quilligan, 2006 ) . This method takes for granted some relationship between cost and value. However, cost-based method has major issue that is associated with historic gaining capacity, and this method has trouble in seting to alternate utilizations of the assets ( Talha, 2004 ) . Historical Cost Accounting–Professionals and Cons Harmonizing to Krumwiede ( 2008 ) , historical cost accounting is the 1 that produces dependable, verifiable information.

Krumwiede emphasizes that fiscal information must incorporate changing grades of relevancy and dependability to be utile but just value accounting, in comparing, does non supply dependable information. Krumwiede besides believes that historical accounting minimizes the usage of estimations and judgements whereas just value accounting that frequently requires important clip for determination procedure. Diana ( 2009 ) states that historical cost accounting is the most utilised accounting method, and the information can be verifiable as the cost is recorded in the papers that proves the belongings right over a certain plus.

One of the most of import advantages of historical cost is objectivity because this accounting method is supported by minutess that have already been completed, and therefore it is apparent and easy apprehensible. Diana learns from other surveies that historical cost accounting should be used for fiscal statement instead than just value accounting because the information provided based on just value is non reliable as they are non based on verifiable minutess.

She besides argues that just value accounting should non be allowed to represent evidences for doing determinations in any instances. Jaijairam ( 2013 ) besides believes that historical cost accounting is easy to understand as it is based on a fixed monetary value that is ever wholly known, specifically the existent monetary value that a company paid. However, Jaijairam besides argues that historical cost accounting perchance underestimates the value of assets depicted on the balance sheet due to depreciation, depletion, and obsolescence.

Another issue of historical cost accounting is that a house utilizing this accounting method may be tempted to pull strings its figures on depreciation to overrate the utile life of an plus or its residuary value. It finally could ensue in overestimated income. Harmonizing to Diana ( 2009 ) , historical cost accounting reflects the existent value of assets at the day of the month of acquisition, but any important subsequent alteration tends to do the historical cost inaccurate and out of day of the month. This besides perchance leads to a regular under-valuation of the assets.

Inflation could be an issue every bit good. Historical cost accounting is an inaccurate contemplation of the existent state of affairs. The assets are under-valuated, and the public presentation of the company can non be assessed right because of over-valuated net income. Particularly for the houses that invest in intangible assets, historical cost accounting fails to reflect the existent capacity of bring forthing future net incomes that expresses the existent value of the house.

Fair Value Accounting–Professionals and Cons Despite her statement on the usage of historical cost accounting, Diana ( 2009 ) besides finds that just value accounting is relevant for fiscal coverage. Harmonizing to Diana, just value accounting ensures a connexion between the value created by the company and its stock market development, allows all executive directors to go cognizant of the costs incurred by all the capital used, and outlines the public presentations broken down in profit-generating units. Fair value accounting besides improves comparison by measuring similar elements in a similar manner.

She besides introduces few advantages of just value accounting ; investors are interested in value, instead than costs, hence fiscal information must be reported utilizing just value in order to supply accurate information for investors ; historical cost becomes irrelevant for set uping the company’s fiscal state of affairs as the monetary value provides an updating of the information sing the value of the assets. In other words, cost does non intend much but monetary value does. Price tells how the company is making with assets and financess ; just value reflects an economic state of affairs.

The just value determined based on market monetary values is non affected by factors that are specific to certain companies. However, just value is frequently considered as excessively unstable and that means it would be excessively easy to pull strings, which makes it unsuitable to be used as an estimation for the value of an plus. Fair value accounting could non be certain to do an estimation as the value is frequently based on the flows expected in the hereafter from the usage of that plus ( Diana, 2009 ) . Krumwiede ( 2008 ) finds that just value accounting seems to compromise the relevancy and comparison of fiscal coverage.

Harmonizing to Krumwiede, just value accounting frequently requires important judgement therefore the rating could be excessively subjective. Besides, the uncertainness in mensurating hazard clearly illustrates the trouble in doing accurate anticipations for finding just value. He specifically states that gauging just value could be even more hard when good will or other indefinite-life intangible assets exist because direction must exert judgement in gauging the life of the good will or other indefinite-life intangible assets.

The inquiry that must be asked is “How could we perchance measure just value that is non ever practical or possible? ” Krumwiede besides inquiries the dependability in just value accounting. Sacrificing a certain grade of dependability in return for more relevant information could be considered as an appropriate tradeoff but at least a sufficient degree of dependability should be presented in fiscal coverage and Krumwiede does non believe that in just value accounting. To the extent different entities use different premises and processs in gauging just value, the comparison would be decreased.

Therefore, if the company chooses historical cost accounting for fiscal intent, that means the company must give up the existent market value and merely depend on the acquisition cost when the company purchased the assets. The company would non be able to reflect the economic rhythm, and that would bring forth overestimated or underestimated income for the company. Historical cost does non state the company the accurate value of assets at the current point, therefore it would be of import to hold plus direction experts.

On the other manus, the company that chooses just market value accounting for fiscal intent must give up objectiveness and the relevancy because of deficiency of old history, minutess, and subjective judgements. The value of assets would be valued by experts, but it would be entirely subjective judgements. The company besides may hold to take a hazard for use by direction because just value is non stable and excessively subjective, therefore it would non be excessively hard to pull strings the value and acquire compensation by overestimated income from the company.

Therefore, it is really of import for companies to understand the advantages and disadvantages of both accounting methods and, tradeoff, therefore the company minimizes the hazard of over or underestimated income for fiscal coverage. The application of historical cost and just value accounting to intangible assets As antecedently stated, intangible assets are an identifiable non-monetary plus without physical substance, therefore it is non likely possible to find exact and accurate value. The value of certain intangible plus may be otherwise valuated by assorted beginnings.

Therefore, the company should carefully make up one’s mind which approach the company will utilize as the value of the intangible plus is difficult to accurately step. Based on my survey, the most of import factor that the companies should see in order to measure intangible assets for fiscal statement is the objectiveness. It is about impossible to mensurate exact value of intangible assets. That is to state, historical cost accounting is a more nonsubjective method than just value accounting because comptrollers easy find historical accounting more nonsubjective based on old minutess and reliable informations.

On the other manus, just value accounting is considered excessively subjective and unstable because most of clip the values are decided by judgement at the current place, but non reflect how the old procedure is done. Accountants and companies besides would be able to foretell how their assets could be valued based on how other companies’ assets were estimated in the yesteryear. Intangible assets are besides reasonably vulnerable to use because this sort of plus is difficult to mensurate, as stated above.

For case, trade name name is an intangible plus and it is impossible to state exact value as it does non even exist. Therefore, without old informations, the value of this trade name name could be estimated rather otherwise by different fiscal experts. This tells that intangible assets are easy told as any monetary value by anyone. Of class, fiscal experts would make some research for income and gauge how much this trade name name helps companies to bring forth this certain income, but there is no exact value to be certain.

Therefore, when historical cost is used for mensurating intangible assets, comptrollers or companies should be able to happen how similar assets have been recognized in a similar market and utilize this information as mentions and groundss before doing a determination for the value of intangible assets. Henry, my foreman and chartered comptroller, besides supports historical cost as the more appropriate accounting method for intangible assets. He besides emphasizes that just value is excessively unstable and difficult to mensurate exact value.

Harmonizing to him, most of clients prefer historical cost for any assets and liabilities including intangible assets because if just value accounting is applied to fiscal statement, it could frequently do two different positions sing the value of certain assets to accountant and concern proprietor because accountant and client might see the current market status and economic rhythm otherwise. It means each person could see same intangible plus otherwise and it possible lead the parties to reason about “the existent value” .

To avoid this sort of fuss, Henry agrees that it would be more appropriate to utilize historical cost accounting which is nonsubjective and apparent with old minutess. Decision This paper discussed how different historical cost and just value accountings are, advantages and disadvantages of both accounting methods, and which one would be more appropriate for intangible assets in fiscal statements. Therefore, based on this research and few surveies, is historical cost accounting more appropriate than just value accounting for intangible assets?

My decision is yes – because historical cost is more nonsubjective, easy to follow, relevant, apparent with old minutess and informations, possible to compare with other companies’ histories and these factors are particularly of import for intangible assets as intangible plus is an identifiable non-monetary plus without physical substance. In decision, historical cost accounting is more appropriate than just value accounting for intangible assets.

References

Diana, C.I. ( 2009 ) . Historical cost versus just value.Annuals of Faculty of Economics, 3 ( 1 ) , 860-865.

Jaijairam, P. ( 2013 ) . Fair Value Accounting V. Historical Cost Accounting.The Clute Institue for Aacademic Research,17, ( 1 ) .

Krumwiede, T. ( 2008 ) . Why Historical Cost Accounting make sense.Strategic Finance.Institute of Management Accountants.9, ( 2 ) , 33,35-39.

Powers, O. ( 1991 ) . Historical Cost Accounting – Are alterations needed?Business Recognition. 93, ( 5 ) , 23.

Quilligan, L. ( 2006 ) . Intangible assets designation and rating under IFRS 3.Accountancy Ireland. 38, ( 3 ) , 10-12.

Reilly, R. ( 2011 ) . Specifying the intangible plus rating assignment.Construction Accounting ; A ; Taxation.21, ( 3 ) , 32-41.

Suntharee, L. ( 2010 ) . Fair value accounting and intangible assets: good will damage and managerial pick.Journal of Financial Regulation and Compliance.18, ( 2 ) , 120-130.

Talha, M. ( 2004 ) . Evaluation of intangible assets in accounting. Construction Accounting ; A ; Taxation. 14, ( 1 ) , 25-31.

Wagner, A. , ; A ; Garner, D. ( 2010 ) . Fair Value Accounting – Fact Or Fancy.Journal of Business ; A ; Economics Research, 8, ( 11 ) , 35.

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