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comparative analysis


Comparative Analysis

Characteristic               Historical Cost                  Fair Value                        Income Recognition

Relevance – Pros        supporters contend that it’s     is determined in a competitive         provides a richer basis for
Info. must have         the most relevant measure as     open market economics and              analysis than cost or mixed
the capacity to help    it focuses on the decisions      embodies all available information     cost. It facilitates the predictive
users make decisions.   and resulting actions to buy     up to the measurement date.            and stewardship purposes of
                        or sell assets and to incur or                                          Financial instruments.
                        settle a liability.

                        measures as a going concern      reflects the markets assessment        FV provides a richer basis for
                        whereas FV will reflect a        of the effects on financial instrum.   prediction as it reflects the
                        liquid measurement.              of current economic conditions.        effects of changes in conditions
                                                                                                and events occurring during the
                                                                                                reporting period.
                        Manufacturing Co’s use HC         does not depend on whether or         FV recognizes income when
                        in order to be competitive and when it is intended to dispose           events take place which enables
                        reflect accurate profits & costs. of an asset or liability.             analysis of economic causes
                                                                                                (changes in market rate of int.)
                                                                                                and their I/S effects.

                        if mgmt intends to hold the      it is the same no matter which         FV maintains the PV of the
                        fin. Inst. until maturity the    enterprise has an asset or liab        markets expectations of future
                        opportunity for gains/losses     if both enterprises have access        cash flows to be generated by
                        are irrelevant as they will      to the same markets.                   the asset discount at the current
                        eventually will net each other                                          available market rate.

                                                         would reduce the anomalies of
                                                         the existing mixed cost acctg.
                                                         therefore reduce the need for
                                                         complex and subjective hedge

                                                         reduces the opportunity for mgmt
                                                         to manipulate earnings.

                                                         recognize derivatives with no
                                                         cost as they are for performance
                                                         in the future – the contract could
                                                         become a large asset or liab.
Characteristic               Historical Cost                      Fair Value                         Income Recognition

Relevance – Cons          measures only the effects of            if an active market does not       gains and losses resulting from
Information must have the conditions that existed when            have a price available FV will     changes in the fin. instru. Are
capacity to help users     the transaction took place and         be measured based on the info      likely to be volatile and non-
make decisions.           only the effects of price               and techniques that provides       recurring and often temporary.
                          changes are reflected only              the best available est.            Provides no basis for prediction
                          only when they are realized                                                of future income and cash flows.
                          or settled.

                             impedes comparability as it          the date used to measure a         concern is expressed that such
                             makes like instruments look          fin. instr. could be outdated      gains/losses may actually serve
                             diff. and diff. instru. look         as soon as statements are          to inhibit the ability of users to
                             alike.                               issued.                            evaluate the sustainable earnings
                                                                                                     of an enterprise.

                             does not reflect current             less relevant as it reflects the   unrealized gains/losses recog-
                             market conditions.                   effects of trans. and events       nised in the I/S in one period
                                                                  in which the entity did not        may reverse to become a loss
                                                                  directly participate.              in future periods – how relevant
                                                                                                     was the gain?

                             ignores the effects of mgmts
                             decisions to hold a fin. instr.
                             as it reflects the effects of
                             changes in FV only when
                             assets are sold or relief from
                             a liab. is obtained not during
                             the period the fin. instr. is held
                             or owned.

Characteristic               Historical Cost                      Fair Value                         Income Recognition

Reliability – Pros         information is outdated but            if there is no observable mkt.     allows investors to evaluate
Information must be        reflects the actual decisions          price FV can be est using tech.    past gains/losses in assessing the
objective and verifiable   and resulting transactions.            that incorporates capital market   potential variability of future
and should faithfully                                             pricing principles and info.       returns as well as future income.
represent what it purports                                        about current mkt. conditions.
to do.

                             no need for mkt. prices or est       there are already est that are     reports gains/losses as income
                             as all financial assets and liab.    accepted in acctg. today           when they occur increases the
                             are recorded at original cost.       eg. defined benefit oblig.         assessment of managements
                             therefore can be verified.           and certain liab provisions.       performance as it attributes
                                                                  reasonable est is an essential     gains/losses to mgmt in place
                                                                  part of the preparation of F/S     when such gains/losses occur
                                                                  and does not undermine their       rather than possibly to a diff.
                                                                  reliability.                       team who may realize them
                                                                                                     at a later date.

                             uses both amortization and           cash flow expectations related directly reflects the gains/losses
                             impairment which help to             to fin. instruments are more   from assuming particular financ.
                             reduce the value of the fin.         faithfully reflected.          risks (int rate and credit risks)
                            instrument.                                                         when the underlying market
                                                                                                condition change.

                                                             software is now available that
                                                             enables many types of compu-
                                                             tations to be made at a reasonable

Characteristic              Historical Cost                  Fair Value                         Income Recognition

Reliability – Cons          requires complex computations market prices are not always          subject to significant est variab.
Info. must be objective     and methods in order to try to available and the est may be         therefore until they are realized
and verifiable and should   est. current mgmt. strategies. unreliable if they are not           or until the est uncertainty has
faithfully represent what                                  based on observable market           been resolved unrealized gains/
it purports to do.                                         prices.                              losses s/b presented separately
                                                                                                outside the I/S.

                            provides mgmt the opportunity    concerns about the ability of      reliable forecasts of the future
                            to manipulate earnings – eg a    an enterprise to develop FV        I/S effects of a fin. instr. are
                            company could play the game      estimates that could be            unlikely to be possible from
                            of “cherry picking” – mgmt       sufficiently reliable for          simple extrapolations of past
                            can improve reported income      financial accounting in            gains and losses.
                            by selecting L/T fin. instr.     all situations.
                            with unrealized gains to be
                            sold or to be reclassified as
                            S/T investments.

                            does not convey the cash         measurement might not be           gains/losses realized by FV
                            flow risks of the company        practical for certain private      takes the markets unbiased
                            on a timely basis as it only     equity investments.                measure of the economic
                            recognizes when realized.                                           events.

                            can be misleading when           although active mkts exist for
                            mgmt has to decide when to       many fin. instr. there is no mkt
                            settle of hold fin. instr.       for loans and deposits.

Characteristic              Historical Cost                       Fair Value                         Income Recognition

Cost-benefit                no additional costs involved     software is now available that     est. of variability (risk) is based
Considerations -            in measuring fin. instr. at FV   enables many types of compu-       on past experience with int rates
Pros                                                         tations to be made at a            and loan defaults – models have
                                                             reasonable cost.                   been developed to utilize statis-
                                                                                                tical data on past experience to
                                                                                                aid analysis.

                            no additional implementation     allows for measuring and           by showing as unrealized gains/
                            issues eg training users and     reporting the results of an        losses it allows for measuring
                            prepares.                        enterprise mgmt strategy           and reporting the results of an
                                                                                                enterprises mgmt strategy.
                        supplies info to see if mgmt   provides investors with                investors and analysts can be
                        is meeting operational budgets valuable info for their decision       expected to want to evaluate
                        or forecasts.                  making – eg FV at retirement           past gains/losses in assessing the
                                                       date, changes in the value and         potential var. or future returns as
                                                       the components of that change.         well as in assessing future
                                                                                              future income expectations.

                        enhances comparability by         costs are no greater than those
                        retaining HC of the fin. instr.   associated with a purchase/sale
                        (provides a trail).               of any asset.

                        Manuf. Co’s rely on HC so         investors are already used to
                        they can compute a cost that      some fin. instru. being measured
                        relates to the original cast of   at FV – RRSP statements.
                        the raw materials.

Characteristic          Historical Cost                        Fair Value                          Income Recognition

Cost-benefit       increase mgmts opportunity to          if there is no active mjt avail.    gain/losses resulting in the FV
Considerations -   manipulate earnings therefore          for valuing a fin. instr. as est.   of fin. instr. are likely to be
Cons               provides less relevant info to users   could incur excessive costs to      volatile and non-recurring
                                                          make reliable est. of the FV of     results of the unexpected there-
                                                          financial instruments.              fore can’t be used for predicting
                                                                                              future income.

                   does not recognize derivatives         there would be an added cost add’l cost involved in measuring
                   with no initial cost therefore lacks   of training both users and      financial instruments at FV
                   relevance to risk mgmt decisions.      prepares (implementation issue)

                   companies are comparing them-          est. and assumptions must be        least benefit to manuf. Co’s. as
                   selves globally to become more         made on a reasonably reliable       they need HC to compute selling
                   competitive, with fin. instr.          and consistent basis resulting      prices to stay competitive.
                   increasing and trying to manage        in an enterprise establishing a
                   risk exposure HC doesn’t supply        system of FV measurement
                   the total picture to investors and     policies and procedures –
                   users.                                 increased costs.

                   costs to users of incomplete info.     added costs of revaluing fin.
                   (need to obtain info not provided      instruments at FV even if an
                   by the F/S)                            active market is available.

                   provides the least benefit to users.

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