COST MEASUREMENT SYSTEM

Replacement Of Traditional Historical Cost Measurement System With A Measurement System Based On Current Market Values



Replacement Of Traditional Historical Cost Measurement System With A Measurement System Based On Current Market Values

Introduction

One of the most important public policy debates in recent years has been the reform of accounting standards toward “fair value” accounting. Financial institutions, especially banks and insurance companies, have been at the forefront of this debate and have been the most vocal opponents of this reform. Judging from the intensity of the arguments and the controversy that this reform has generated, there is clearly much more at stake than what may appear to be esoteric measurement issues. We review the main strands of this debate, and describe a framework of analysis that can weigh up the arguments on both sides. Far from being an esoteric debate, issues of measurement have a far reaching influence on the behaviour of financial institutions, and determine to a large extent the efficiency of the price mechanism in guiding real decisions. The immediate cause of the recent fierce debates has been the initiative of the International Accounting Standards Board (IASB) and the U. S. Financial Accounting Standards Board (FASB) toward greater convergence of international accounting standards to one based more on the information that are provided by prevailing market prices - sometimes known as a “fair value” or “mark-to-market” reporting system (Hansen (2004)). This is in contrast to a measurement system based on historical cost which requires firms to record their assets and liabilities at their original prices with no adjustments for subsequent changes in the market values of those items.

Literature Review

The restructure in the direction of greater assessing to market has had many influential champions. In testimony to U.S. House of representatives, Paul Volcker, chairman of the Board of Trustees of the International Accounting Standards Committee, has stated that one of the fundamental conceptual issues facing accounting regulators worldwide is the “extent to which standards should move away from traditional cost based accounting to marking assets and liabilities to market.....” (Volcker (2001)). Robert Herz, chairman of the Financial Accounting Standards Board has argued that “for accounting to better reflect true economic substance, fair value, rather than historical cost, would generally seem to be the better measure.” (Herz (2003)). Other ones have called the move to a fair worth measurement scheme “the biggest move in accounting and financial describing since benchmark setting was set up” (Williams (2002)). Some in the well liked press have gone further. One commentator writes “Maybe, if businesses in the joined States and Asia had assessed all financial devices at equitable value, controllers, depositors, and investors could have accomplished greater regulatory and market control and respect and avoided some of the losses that investors and taxpayers have had to pay throughout previous downturns in the finances” (Day (2000))(Day, 2000, 21).

However, arrayed against this formidable line-up has been an equally formidable group of banks and insurance companies drawn from the major industrialized countries, sometimes with the support ...