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Financial accounting utilizing U.S. standards has primarily been based on historical cost. In business combinations, book...

Financial accounting utilizing U.S. standards has primarily been based on historical cost. In business combinations, book value and carrying value on bonds can become relevant. In addition, fair market value of other assets may also become a factor. Discuss the pros and cons of each method of valuation. Which method do you feel is the best for valuation of assets? Explain in about 100 words and give references

Expert Solution

Historical Cost: It is the acquisition cost or Cost of Construction in case of it is constructed.

Pros:

(i) Actual cost of the asset will be shown in the financial statements

(ii) It is more reliable and accurate

Cons:

(i) Asset value shown at cost in the financial statements, it ignores any price changes such as subsequent price increase or decrease of the asset

(ii) It ignores the Depreciation, amortization etc.; Therefore financial statements of the entity can not give true picture of the entity's financial position

Fair value method: It is a reasonable estimated value of an asset

Pros:

(i) Asset value shown at fair value in the financial statements, It considers any price changes such as subsequent price increase or decrease of the asset

(ii) It considers Depreciation or amortization as a charge on some of the assets like plant, machinery & equipment to get clear picture of the financial position

Cons:

(i) Estimates are reasonable and it do not produce exact value of the assets.

(ii) Fair value is depend upon the so many factors like depreciation rates, method of accounting principles etc. It is difficult to estimate the depreciation, adoption of accounting policies, estimate the use life of assets etc.

The best method of valuation is fare value method because of the following reasons:

(i) Carrying amount of the asset in fair value method is more appropriate as the value is closed to the market value where as the carrying amount in historical cost is actual cost of the asset.

(ii) Fair value method will provide true financial position of the business entity.

(iii) Fair value method is more appropriate and generally acceptable

ekkarill92 answered 2 days ago

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