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Video 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 $1,000,000 and I buy the land for 1.2 million dollars so I have 2.2 million dollars in assets nothing confusing there now let's go to year 2 and think about how we want to account for the sheep and the land so one way we could say is look the sheep are still there the land is still there I paid a million dollars for the Sheep and they're all still there so I'll put on my books that the sheep are still 1 million dollars and I paid 1.2 million dollars for the land so I'll put on my books that the land is 1.2 million dollars 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 historical cost now another and 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 have to say like 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 well your sheep are looking good there's been a big I don't know sheep epidemic in another part of the country should 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 $2,000,000 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 dollars let me put 2 million dollars for my sheep and let's say that the land has also appreciated that you know the highways gone by and someone wants to put build a development nearby so there's the fair value of your land has also gone up maybe it's also 2 million dollars so both of these so this is 2 million and this is 2 million so this right over here you could view this the market value or the fair value the fair value of your sheep now I 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 the mark to market value as as frequently as possible it's very easy to do if there is kind of a market in that or you can get an appraiser 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 it sounds like very fancy words but it's a pretty simple idea