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Hans Hoogervorst speaks about historical cost and fair value

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29 Jun 2015

At the IFRS Foundation's IFRS conference currently held in Paris, IASB Chairman Hans Hoogervorst spoke about the question of how assets and liabilities should be measured, a topic he called "one of the most difficult topics in accounting".

Mr Hoogervorst pointed at the fact that the recently published Exposure Draft containing proposals for topical areas where the IASB considers a revision and amendment of the existing Conceptual Framework necessary also includes a chapter on measurement offering a description of different measurement bases, the information that they provide and their advantages and disadvantages. In this chapter, the IASB has have divided the measurement techniques into two categories: historical cost and current value. However, Mr Hoogervorst pointed out that "the dichotomy between historical cost and fair value is not as stark as one would expect". He listed four aspects where the assumed stability of historical cost and the often cited vulnerability of current value are not necessarily that far apart. He cited

  • the fact that, for many transactions, historical cost starts and ends with fair value (or values that come very close to it);
  • that, despite its name, historical cost gets updated too (depreciation/amortisation);
  • that the alleged stability resulting from historical cost accounting can be extremely misleading; and
  • that the stability of historical cost can be interrupted by steep cliff effects.

He summed up:

In conclusion, historical cost is to some extent based on fair value; it needs a degree of current measurement to maintain its relevance, it is not free from subjective updating requirements; and it is not necessarily stable. Moreover, historical cost is also vulnerable to abuse. In sum, all the vulnerabilities that are often attributed to fair value accounting can be equally pertinent to historic cost.

However, Mr Hoogervorst also stated that it would not do to abandon historical costs completely in favour of fair value. Instead, he noted in "very broad brushstrokes indeed" the following general conclusions as to when the different categories of measurement bases should be applied:

  • If the nature of business activities is to use assets in combination with other assets to produce goods or services, this generally points in the direction of historical cost.
  • If the nature of business activities is to trade assets or liabilities in active markets, this would generally point in the direction of current value measurement.
  • If the characteristics of an asset of a liability are such that they are highly sensitive to market factors or to other risks in the item, this would generally point in the direction of current value measurement.

He also noted of course that more factors than these will need to be taken into consideration, such as the cost of performing the measurement, the degree of measurement uncertainty, faithful presentation and the avoidance of accounting mismatches. He encouraged his audience to comment on the proposals in the IASB's Exposure Draft.

The full transcript of Chairman Hoogervorst’s speech is available on the IASB’s website.

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