Comparison with Historical Cost Accounting The main alternative to fair-value accounting is “historical-cost accounting. ” Here, assets are recorded at historical cost, which generally equals the fair value when the assets were originally purchased. Subsequently, historical costs are adjusted for amortization and impairments, but not for increases in asset values. Impairments have been a part of historical-cost accounting for decades and occur when the fair value of an asset falls below its amortized cost. When asset values decline and impairment is unrestricted, fair-value accounting and historical-cost accounting are ancestrally the same.
However, in practice, the impairment test differs across assets. Moreover, whether or not the book value of an impaired asset is written down and the loss is recognized in the income statement depends on the asset in question and, in many cases, on whether the impairment is deemed as “other than temporary. ” As long as Level 1 inputs?prices from active markets for the same asset ?are available, overvalue accounting provides little room for manipulation and generally provides reliable information.
To the extent that Level 2 inputs have to be used, fair-value accounting offers some discretion to management.
With Level 3 inputs, management has considerable discretion. Historical-cost accounting offers little room for manipulation as long as original purchase prices or amortized costs are used, but this information is often criticized for not being relevant or timely. There is considerable discretion with respect to whether an asset is treated as impaired. Moreover, because historical-cost accounting does not recognize gains unless the asset is sold, it may provide incentives for banks to selectively sell (and repurchase) assets that trade in liquid markets and have appreciated in value.
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Comparison with Historical Cost Accounting. (2017, Sep 27). Retrieved from https://graduateway.com/comparison-with-historical-cost-accounting/