Question

Explain the reason for not reporting property and equipment at fair value except in specified circumstances.

Answer 1

Carrying value and fair value are two different accounting measures used to determine the value of a company's assets.

The carrying value (book value), is an asset value based on the company's balance sheet, which takes into account, the cost of the asset and depreciation is deductible over time. The fair value of an asset is usually determined by the market and agreed upon by a willing buyer and seller, and it can fluctuate often. In other words, the carrying value generally reflects equity, while the fair value reflects the current market price.

Because the fair value of an asset can be more volatile than its book value, it's possible for big discrepancies to occur between the two measures. The market value can be higher or lower than the carrying value at any time. These differences usually aren't examined until assets are appraised or sold to help determine if they're undervalued or overvalued.

Historical cost is both an objective and a reliable measure, determined by a willing buyer and a willing seller. In contrast, any gathering of “experts” could assess the value of a large building or an acre of land at widely differing figures with equal certitude. No definitive value can possibly exist until sold. The fair value of property and equipment is a reporting alternative preferred by some decision makers, but only if the amount is objective and reliable.

For that reason, historical cost, as adjusted for accumulated depreciation, remains the accepted method for reporting property and equipment on an organization’s balance sheet and not the fair value method except in specified circumstances.