Lancaster University Management School - Accounting and Finance

One of the central functions of accounting is to record firms’ transactions using an appropriate measurement basis. Historical cost accounting was the dominant measurement basis for much of the 20th century, but in the last decades accounting bodies around the world have systematically introduced fair value measurement. Historical cost generally refers to the amount a firm paid for an asset (or an obligation assumed for a liability) at the initial transaction date. Under historical cost measurement, assets and liabilities are recorded at historical cost, with remeasurement encompassing depreciation, amortisation, and impairment charges. Under fair value measurement, an asset is recorded in the financial statements at the estimated price that the firm would have received if it had sold the asset at the reporting date. Similarly, a liability is recorded at the estimated price the firm would have paid to transfer the liability. When the price for an asset/liability is not observable in the market, its fair value is estimated using a valuation technique. Currently in accounting, we have a model where firms measure some assets/liabilities at fair value and some at historical cost, which leads us to an important question. IS IT TIME FOR A CHANGE? Whether we should move to full fair value measurement is a fundamental question, as high-quality financial information is critical for the stability of the markets. Academics, policymakers, and practitioners alike have sought to attribute both positive and negative capital market outcomes to fair value measurement. On the one hand, critics say estimating fair values when assets and liabilities are not traded involves unavoidable measurement error. Critics also argue that when the prices of assets/ liabilities are not observable in an active market, fair value measurement offers managers opportunities for earnings management. On the other hand, proponents argue fair values are more relevant than historical cost, providing useful 26 | ‘‘ ’’ Currently in accounting, we have a model where firms measure some assets/liabilities at fair value and some at historical cost...

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