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Finance and capital markets
Course: Finance and capital markets > Unit 5
Lesson 2: Three core financial statementsFair value accounting
Difference between Historical Cost and Fair Value Accounting. Created by Sal Khan.
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Is 'fair value' sometimes referred to as 'mark-to-market'?(12 votes)
fair value is the official term used by the FASB (the organization that makes accounting rules) and mark-to-market is the word used by practitioners and the media.(34 votes)
- At2:22he mentions most accounting standards boards want you to report the fair value. If there is an "appraiser" available for that asset, is there a requirement or expectation to do an appraisal every year or x years to keep up with your fair market value?(9 votes)
You are right, there is an expectation of frequency of appraisals, yet they differ between standards, markets and asset groups. In general as frequent as its necessary to show fair value. It can be annually but in most cases 3 to 5 years. For networks and infrastructure it can go up to 10 years.
IAS 16 states in 31 "Revaluations shall be made with sufficient regularity to ensure that the carrying amount does not differ materially", it expands in 34 "Some items of property, plant and equipment experience significant and volatile changes in fair value, thus necessitating annual revaluation. Such frequent revaluations are unnecessary for items of property, plant and equipment with only insignificant changes in fair value. Instead, it may be necessary to revalue the item only every three or five years."(15 votes)
Does the Historical Value is same as Book Value? If no than what is the difference between Historical Value and Book Value?(7 votes)- Usually historical value means the value that was originally recorded when the asset or liability was first put on the balance sheet.
The book value is similar, but it can change over time due to things like write downs and re-valuation due to impairment.(11 votes)
Does the historical value account for inflation? Why or why not?(8 votes)- So lets so you bought a piece of land for $1.5 mil 30 years ago and now the land value is $30 mil. With Historical Value, you still only put land value down as $1.5 mil not $30 mil.(1 vote)
If you had your assets appraised, say, two years ago, and never had them reappraised, would the fair value become the historical value after it was appraised? Or would the historical value still stand, and any reports afterward revert back to the initial value at purchase?(4 votes)
It will become historical value. In order to call a value which you give it a fair value, you need to continue getting it appraised regularly.(7 votes)
When your asset value increases, does that count as income that you have to pay taxes on? Like income tax or capital gains tax?(7 votes)- Only if it is sold, and you actually cash in on that appreciated value.(1 vote)
How sheep & land value increase affects passive side of balance sheet?(4 votes)- sheep and land after it is appraised will increase or decrease your assets and equity.(2 votes)
Is it true that fair value (instead of historical cost) accounting is the trend which the IFRS and the US GAAP are currently following? If that's so, what are the benefits and the drawbacks?(2 votes)- Yes...kind of. There are literally different rules for every line item on financial statements. But, things that are bought and sold on a regular basis and can be easily valued are usually valued at fair value or something close to it. Or, like inventory, it will be at historical cost, or fair market value, whichever is lower.
Things that are more difficult to value, or aren't used as often, like land, goodwill, PP&E, intangible assets, securities held to maturity and long term debt, are held at historical cost, or depreciated cost. They are usually tested at least annually for impairment. Meaning if they have been deemed to have lost a significant amount of value, they will be written down to a lower value.(6 votes)
So, what if the historical value is more then the fair value?(1 vote)
Forgetting standards for a minute, it just means that you are over estimating the actually worth of the asset, and if you liquidated your assets and payed your liabilities, you would have less cash than you previously had budgeted.(6 votes)
- 00:23about how we want to account for the sheep and the land
In this sentence, what does mean for 'account for'?(1 vote)- It means how we want to decide their values.(3 votes)
2:22Video transcript
Let's say I run some type of
sheep farm, maybe some type of wool producing business. And in year one, I go out
there, I buy a bunch of sheep, and I put them on some land. And I go and I buy the
sheep for $1 million. And I buy the land
for $1.2 million. So I have $2.2
million in assets. Nothing confusing there. Now, let's go to
year two, and think about how we want to account
for the sheep and the land. So one way we could
say is, oh look, the sheep are still there. The land is still there. I paid a $1 million
for the sheep and they're all still there. So I'll put on my books that
the sheep are still $1 million. And I paid $1.2
million for the land. So I'll put on my books that
the land is $1.2 million. So in this situation,
I've accounted for the sheep and the land
based on their historical cost. So let me write this down. This is based on
historical cost. Now, this is a legitimate way to
account for things, especially if there's no other
way to really think about what my sheep
or my land are worth. I'd say, look, this is
what I paid for them. Now let's say that there is
an active market in sheep, and you can get
a sheep appraiser to come over to your
farm and tell you what your sheep are worth. And your sheep appraiser
comes and says, wow, your sheep
are looking good. There's been a big-- I
don't know-- sheep epidemic in another part of the country. So there's a sheep shortage. So your sheep are
actually worth a lot more than they were last year. And they say, I think your
sheep are now worth $2 million. So you say, hey, wow, the
market value of my sheep is $2 million. So you could say, well, instead
of putting $1 million there, let me put $2 million. Let me put $2
million for my sheep. And let's say that the
land is also appreciated. A highway's gone by
and someone wants to build a development nearby. So the fair value of your
land has also gone up, maybe it's also $2 million. So both of these. So this is $2 million. And this is $2 million. So this right over
here, you could view as the market value or
the fair value of your sheep. Now, either one of these are
legitimate ways of accounting, but it's good to
know the difference. This is historical
cost accounting. This is fair value accounting. In general, most
accounting standards boards want people to
report the fair value or to market value as
frequently as possible. And it's very easy
to do if there is kind of a market in that. Or you can get an appraiser
in and they can give you a pretty good estimate of
what these things are worth. If that isn't around, or if
it's just inefficient to do it, then you'd probably want to
do the historical cost method. So that's all the difference. Historical cost, how
much you paid for it. Fair value, what's the
current market value today. So they sound like
very fancy words, but it's a pretty simple idea.