Question

What is the impact on both the balance sheet and income statement when companies shift from a historic cost basis to a fair value basis?

Answer 1

Shifting from a historic cost basis to fair value basis can have a significant impact on the balance sheet and income statement of the company.

Historic cost represents a basis wherein assets and liabilities are measured at the initial price exchanged at the time of the transaction.

Under the fair value basis, the values of assets and liabilities are periodically (generally every rpeorting period) updated to represent the fair market price of the asset.

Therefore, moving from the historic cost approach to fair value approach can have significant impact on the entity, Depending on the nature of assets, and as the fair value measurements are generally routed through the profit and loss account in most cases, movement from historic cost to fair value meaasurement generally exposes the profit and loss account to a lot of volatility. Also, as the corresponding impact is on the assets/liabilities in the balance sheet, the balance sheet numbers and ratios are also subject to volatility.