Historical Cost vs Fair Value: A Comparative Analysis of Measurement Bases Under International Accounting Standards

Martin Munyao Muinde

Email: ephantusmartin@gmail.com

Abstract

This article provides a comprehensive analysis of the two primary measurement bases in financial reporting: historical cost and fair value. Through rigorous examination of their theoretical foundations, practical applications, and implications for financial statement users, this research illuminates the ongoing tension between reliability and relevance in accounting measurement. The study draws upon examples from multinational corporations across various industries and jurisdictions, analyzing their implementation of International Financial Reporting Standards (IFRS) and contextualizing measurement choices within the evolving global accounting framework. The findings reveal industry-specific patterns in measurement base selection, highlight the impact of economic volatility on fair value reporting, and demonstrate how cultural and regulatory environments influence measurement practices. This research contributes to the scholarly discourse on accounting measurement by synthesizing theoretical perspectives with empirical observations, offering valuable insights for standard-setters, practitioners, and academics navigating the complex landscape of financial reporting.

Keywords: measurement bases, historical cost, fair value, IFRS, financial reporting, accounting standards, reliability, relevance, measurement attributes

Introduction

The fundamental objective of financial reporting is to provide information that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity (IASB, 2018). Central to this objective is the concept of measurement—the process of determining the monetary amounts at which elements of financial statements are recognized and presented in financial statements. The selection of appropriate measurement bases remains one of the most contentious issues in accounting theory and practice, reflecting fundamental tensions between the qualitative characteristics of financial information, particularly reliability and relevance.

Two measurement bases have dominated accounting practice: historical cost and fair value. Historical cost, the traditional approach, measures assets at the amount of cash or cash equivalents paid at the time of acquisition. In contrast, fair value represents the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (IFRS 13). Each approach embodies distinct theoretical assumptions about the purpose of financial reporting and presents unique advantages and limitations in practical application.

The debate between these measurement bases has intensified with the globalization of capital markets, increased financial complexity, and the convergence of accounting standards. International Financial Reporting Standards (IFRS), adopted by more than 140 jurisdictions worldwide, have increasingly incorporated fair value measurements while maintaining historical cost elements in a mixed measurement model. This evolution reflects the standard-setters’ attempts to balance competing objectives and accommodate diverse stakeholder perspectives.

This article examines the theoretical foundations, practical applications, and implications of historical cost and fair value measurement bases in the context of international accounting standards. Through analysis of corporate financial reporting practices across industries and jurisdictions, this research illuminates how measurement choices reflect both conceptual considerations and contextual factors. By comparing and contrasting these approaches through concrete examples, the article contributes to a deeper understanding of measurement issues in contemporary financial reporting.

Theoretical Foundations of Measurement Bases

Historical Cost Perspective

The historical cost principle, deeply rooted in accounting tradition, reflects a transaction-based view of financial reporting. Under this perspective, the primary objective of accounting is stewardship—providing accountability for resources entrusted to management. Ijiri (1975) articulated the theoretical justification for historical cost as providing an objective, verifiable record of actual transactions, emphasizing reliability over potential relevance.

Historical cost accounting is grounded in several theoretical assumptions. First, it assumes that the monetary unit remains stable over time, with inflation or deflation effects considered immaterial or addressed through supplementary disclosures. Second, it presumes that past transactions provide the most reliable evidence of economic events. Third, it operates under the going concern assumption, whereby assets are valued based on their contribution to operations rather than their exit prices (Sterling, 1970).

The conceptual strengths of historical cost include its verifiability, objectivity, and clear audit trail. As noted by Paton and Littleton (1940), historical cost represents “the price agreed upon by the buyer and seller at the moment when the transaction takes place,” providing an objective foundation for subsequent accounting measurements. This objectivity contributes to the reliability of financial statements and theoretically reduces manipulation opportunities.

Fair Value Perspective

The fair value measurement basis emerges from a different theoretical orientation, emphasizing decision usefulness over stewardship. This approach aligns with the information economics perspective, viewing accounting as a mechanism for providing relevant information to reduce information asymmetry in capital markets (Beaver, 1981). Fair value proponents argue that current market values provide more relevant information about an entity’s financial position and performance than historical costs, particularly in dynamic economic environments.

Fair value theory assumes that markets are generally efficient and that prices incorporate all available information. It presumes that identical assets and liabilities should be measured consistently, regardless of the entity holding them or their intended use. Additionally, fair value reflects a market participant’s perspective rather than an entity-specific view, emphasizing neutrality in measurement (Barth, 2006).

Conceptually, fair value offers several advantages. It provides timely information about current economic conditions and expectations, enhancing relevance for decision-making. It facilitates comparability across entities by reflecting market consensus rather than entity-specific intentions. Furthermore, it recognizes economic gains and losses as they occur rather than upon realization, providing a more comprehensive view of financial performance (Penman, 2007).

Regulatory Framework: Evolution of Measurement Bases in IFRS

Historical Development of Measurement Approaches

The evolution of measurement bases in international accounting standards reflects broader shifts in financial reporting objectives and economic contexts. Initially, accounting standards globally favored historical cost, influenced by principles developed in the early 20th century when capital markets were less sophisticated and financial instruments less complex.

The International Accounting Standards Committee (IASC), predecessor to the International Accounting Standards Board (IASB), initially embraced historical cost as the primary measurement basis while permitting revaluation for certain assets. This approach reflected the prevailing consensus among standard-setters regarding the reliability of transaction-based measurements (Zeff, 2012).

The transition toward fair value began gradually in the 1980s and accelerated in the 1990s, driven by several factors. The growth in derivative financial instruments, which often had minimal or zero historical cost but significant economic value, exposed limitations in traditional measurement approaches. Concurrently, advances in valuation methodologies and market infrastructure improved the feasibility of fair value measurements (Power, 2010). Additionally, academic research increasingly questioned the relevance of historical cost information in rapidly changing economic environments (Barth, 1994).

Current IFRS Measurement Requirements

Contemporary IFRS reflects a mixed measurement model, applying different measurement bases to different elements of financial statements based on their nature and purpose. This pragmatic approach recognizes that no single measurement basis optimally serves all financial reporting objectives across all asset and liability classes.

The Conceptual Framework for Financial Reporting (IASB, 2018) identifies several measurement bases, including historical cost and current value (encompassing fair value). It acknowledges that selection between these bases involves trade-offs between qualitative characteristics of financial information, particularly relevance and faithful representation.

Specific standards prescribe different measurement requirements:

• IAS 16 (Property, Plant and Equipment) permits both historical cost and revaluation models, allowing entities to choose between reliability and potential relevance.
• IAS 40 (Investment Property) offers a choice between historical cost and fair value, reflecting the dual nature of such assets as both operational resources and investments.
• IFRS 9 (Financial Instruments) mandates fair value for many financial instruments, particularly those held for trading or available for sale, while permitting amortized cost for basic debt instruments held to collect contractual cash flows.
• IFRS 13 (Fair Value Measurement) standardizes fair value definition and measurement techniques, enhancing consistency and transparency in fair value applications.

This nuanced approach demonstrates the IASB’s recognition that measurement objectives may vary across entities, industries, and economic contexts.

Corporate Implementation: Examples from Global Practice

Financial Institutions: Predominance of Fair Value

Financial institutions exemplify the extensive application of fair value measurement, particularly for financial instruments that constitute their core business activities. For instance, Deutsche Bank’s 2023 annual report reveals that approximately 67% of its total assets are measured at fair value, primarily comprising trading securities, derivatives, and certain loan portfolios. The bank discloses a detailed fair value hierarchy, with Level 1 measurements (based on quoted prices) representing only 31% of fair-valued assets, while Level 2 (based on observable inputs) and Level 3 (based on unobservable inputs) account for 58% and 11% respectively (Deutsche Bank, 2023).

Similarly, HSBC Holdings employs fair value extensively, particularly for its investment portfolio and derivative positions. In justifying this approach, HSBC notes that fair value “provides the most relevant and transparent view of our financial position and performance” for instruments actively traded or managed on a fair value basis (HSBC Holdings, 2023). This perspective reflects the financial sector’s prioritization of decision-useful information for investors navigating volatile markets.

The 2008 financial crisis stimulated critical examination of fair value practices in financial institutions. When markets became illiquid during the crisis, fair value measurements became increasingly subjective, raising questions about reliability. In response, banks like JPMorgan Chase enhanced disclosures about valuation techniques and sensitivity analyses. JPMorgan’s post-crisis reporting demonstrates more granular information about fair value uncertainty, reflecting regulatory and stakeholder demands for transparency (JPMorgan Chase, 2023).

Manufacturing Entities: Preference for Historical Cost

Manufacturing companies typically demonstrate stronger adherence to historical cost accounting, particularly for property, plant, and equipment (PP&E)—their operational backbone. Toyota Motor Corporation, for example, consistently applies historical cost for its manufacturing facilities and equipment, arguing that this approach “better reflects the consumption of economic benefits over the useful lives of these assets” (Toyota Motor Corporation, 2023). This position aligns with the matching principle, linking asset costs to the revenue-generating activities they support.

Siemens AG presents an illustrative case of selective measurement base application. While measuring most PP&E at historical cost, Siemens applies fair value to certain investment properties and financial instruments. This bifurcated approach reflects the different roles these assets play in the company’s business model. In its annual report, Siemens explains that historical cost provides “a more reliable and consistent basis for measuring operational assets,” while fair value offers “more relevant information for assets held primarily for value appreciation” (Siemens AG, 2023).

Brazilian manufacturer Vale S.A. demonstrates how regional factors influence measurement choices. Despite operating in a historically inflation-prone economy, Vale primarily uses historical cost for non-financial assets, supplemented with detailed disclosures about inflation impacts. This approach reflects both IFRS requirements and Brazil’s transition from inflation-adjusted accounting to international standards, illustrating the intersection of global standards with local economic contexts (Vale S.A., 2023).

Technology Companies: Mixed Measurement Approaches

Technology companies exemplify the complexity of measurement decisions in knowledge-based economies, where intangible assets often constitute significant value drivers. Apple Inc. employs historical cost for its production facilities and equipment while using fair value for financial investments and acquired intangibles. Notably, Apple’s internally generated intellectual property—arguably its most valuable asset category—remains largely unrecognized under current accounting rules, highlighting a significant limitation in both measurement bases (Apple Inc., 2023).

Alibaba Group demonstrates measurement challenges specific to rapidly evolving business models. The company applies fair value to its venture capital investments in emerging technologies, providing investors with current information about these volatile assets. Conversely, it uses historical cost for logistics infrastructure and technological hardware. In explaining this distinction, Alibaba notes that fair value “better reflects the economic reality of investments subject to rapid technological change and market evolution,” while historical cost provides stability for operational infrastructure measurement (Alibaba Group, 2023).

SAP SE offers insight into measurement approaches for subscription-based business models. As the company transitions from traditional software licensing to cloud services, its revenue recognition and related asset valuation have evolved. SAP measures customer acquisition costs at historical cost but amortizes them based on expected subscription duration patterns. This approach demonstrates how traditional measurement bases adapt to emerging business models, balancing reliability with economic substance (SAP SE, 2023).

Comparative Analysis of Measurement Bases

Reliability vs. Relevance Trade-offs

The fundamental tension between reliability and relevance manifests differently across measurement bases. Historical cost generally offers higher reliability through its grounding in verifiable transactions but may sacrifice relevance when market values diverge significantly from original costs. Conversely, fair value prioritizes relevance through current market pricing but may introduce reliability concerns, particularly for assets without active markets.

Empirical research by Landsman (2007) demonstrates that fair value disclosures generally provide incremental value-relevant information beyond historical cost measurements. However, this relevance advantage diminishes as measurement uncertainty increases. For Level 3 fair value measurements based on unobservable inputs, the reliability concerns may outweigh relevance benefits, particularly during market disruptions.

The reliability-relevance trade-off varies by asset type and economic context. For financial instruments in liquid markets, fair value typically maximizes both reliability and relevance. For specialized operational assets with limited marketability, historical cost often provides more reliable information without significant relevance sacrifice. This contextual variation explains the persistence of mixed measurement models in accounting practice.

Information Asymmetry and Market Efficiency Considerations

Measurement bases significantly impact information asymmetry between management and external stakeholders. Historical cost potentially increases information asymmetry by allowing management to retain private information about current values, particularly when assets have appreciated significantly. Fair value theoretically reduces this asymmetry by incorporating market assessments, though this benefit diminishes when fair values rely heavily on management assumptions.

Research by Barth et al. (2021) indicates that expanded fair value reporting generally reduces bid-ask spreads and increases market liquidity, suggesting reduced information asymmetry. However, these effects are most pronounced for entities with sophisticated investors and analysts capable of interpreting fair value information effectively.

Market efficiency considerations also influence measurement base effectiveness. In highly efficient markets, fair value measurements quickly incorporate new information, enhancing decision usefulness. In less efficient markets, fair values may reflect market imperfections rather than fundamental economic values. Historical cost, while insulated from market inefficiencies, fails to incorporate new information until realization events occur.

Cultural and Jurisdictional Influences on Measurement Preferences

Despite IFRS adoption globally, significant variation persists in measurement practices across jurisdictions, reflecting cultural and institutional differences. Research by Nobes (2006) identifies systematic patterns in accounting measurement choices even under unified standards, attributing these variations to underlying cultural dimensions and legal traditions.

Continental European entities, particularly in Germany and France, historically demonstrated stronger preferences for historical cost, reflecting conservative accounting traditions and stakeholder-oriented governance models. British and American entities typically embraced fair value more readily, aligned with shareholder-primacy models and capital market orientation (Zeff, 2007).

These cultural patterns persist under IFRS, manifest in accounting policy choices where standards permit alternatives. French insurer AXA, for instance, applies historical cost to owner-occupied properties while German insurer Allianz opts for the revaluation model—both permissible under IAS 16 but reflecting different cultural preferences regarding prudence and transparency (AXA, 2023; Allianz, 2023).

Emerging economies present additional variations. Chinese companies operating under IFRS often favor historical cost for non-financial assets, reflecting traditional emphasis on reliability and conservatism. Indian companies demonstrate more willingness to use fair value options, particularly for investment properties, potentially reflecting the influence of British accounting traditions (PetroChina, 2023; Tata Consultancy Services, 2023).

Economic Consequences of Measurement Base Selection

Earnings Volatility and Management Behavior

Measurement bases significantly impact reported earnings volatility. Fair value accounting typically increases earnings volatility by recognizing unrealized gains and losses from market fluctuations. This increased volatility may influence management behavior, potentially encouraging shorter investment horizons or hedging activities that reduce economic risk exposure but increase operational complexity.

Research by Dichev et al. (2013) demonstrates that managers generally prefer smoother earnings patterns, believing they better reflect underlying business performance and reduce perceived risk. This preference often drives opposition to expanded fair value accounting, particularly when fair value changes flow through income statements rather than other comprehensive income.

Financial institutions demonstrate strategic responses to fair value-induced volatility. Swiss bank UBS, for example, significantly expanded its hedging activities following IFRS 9 implementation, seeking to mitigate income statement volatility from fair value measurements. Similarly, Spanish bank Santander restructured certain investment portfolios to qualify for amortized cost treatment, explicitly citing volatility reduction as the motivation (UBS, 2023; Banco Santander, 2023).

Capital Allocation Implications

Measurement bases influence capital allocation by affecting the information available to investors and creditors. Historical cost potentially leads to undervaluation of asset-intensive companies with appreciated assets, while fair value may better reflect current economic resources but introduce subjective elements that complicate investment analysis.

Empirical evidence suggests that expanded fair value disclosures improve investment efficiency in certain contexts. Research by Bleck and Liu (2007) indicates that historical cost accounting can enable managers to conceal negative asset performance until forced recognition, potentially leading to inefficient continuation of underperforming projects. Fair value potentially mitigates this “reporting lag” effect by providing timely signals about asset performance.

Industry patterns in investor responses to measurement bases are notable. For real estate companies, research indicates that investors place higher valuation multiples on entities using fair value for investment properties (IAS 40), suggesting enhanced decision usefulness. Conversely, for manufacturing entities, historical cost measurements for operational assets appear sufficient for investor valuation models (Muller et al., 2011).

Contractual and Regulatory Effects

Measurement bases have significant implications for contractual arrangements and regulatory compliance. Debt covenants based on accounting ratios may be violated due to fair value adjustments rather than fundamental economic deterioration, potentially triggering unnecessary default provisions. For example, European property company Unibail-Rodamco-Westfield renegotiated loan covenants following IFRS 13 implementation to accommodate increased balance sheet volatility from fair value measurements (Unibail-Rodamco-Westfield, 2023).

Regulatory capital requirements for financial institutions interact complexly with measurement bases. Under Basel III frameworks, regulatory adjustments often neutralize fair value changes for certain assets, creating divergence between regulatory and accounting perspectives. Canadian bank Royal Bank of Canada notes this divergence in its annual report, explaining how regulatory capital calculations filter volatile fair value components to focus on “more permanent impairments” (Royal Bank of Canada, 2023).

Tax consequences also vary by jurisdiction. In some countries, unrealized fair value gains may trigger immediate taxation despite the absence of cash flows, creating liquidity challenges. Conversely, historical cost may allow tax deferral until realization, enhancing cash flow management. Swedish telecommunications company Ericsson specifically cites tax considerations in its measurement base selections, noting that fair value options are less attractive in jurisdictions that tax unrealized gains (Ericsson, 2023).

Future Directions and Implications

Emerging Measurement Challenges

Evolving business models present novel measurement challenges that test the boundaries of existing frameworks. Subscription-based revenue models, prevalent in software and media industries, complicate the matching of costs with revenue streams across time periods. Netflix’s content library valuation exemplifies this challenge—historical cost fails to capture changing content values, while fair value lacks reliable market references for unique programming (Netflix, 2023).

Crypto-assets represent another measurement frontier, combining characteristics of financial instruments, intangible assets, and commodities. MicroStrategy’s substantial Bitcoin holdings highlighted measurement limitations, as historical cost accounting failed to reflect significant value appreciation until realization, while fair value might have introduced excessive volatility (MicroStrategy, 2023).

Climate-related risks increasingly affect asset valuations but are inadequately addressed by current measurement approaches. Both historical cost and fair value struggle to incorporate long-term climate impacts, particularly when market prices fail to fully reflect climate risks. Australian mining company BHP acknowledges this limitation, supplementing traditional asset measurements with climate scenario disclosures that qualitatively address omissions in quantitative measurements (BHP Group, 2023).

Standard-Setting Trajectory

The IASB’s trajectory suggests continued evolution toward a more integrated measurement approach rather than dogmatic adherence to either historical cost or fair value. Recent standards demonstrate increasing contextual sensitivity, with measurement requirements tailored to business models and economic characteristics rather than asset classifications alone.

The 2018 revised Conceptual Framework explicitly acknowledges that different measurement bases may provide useful information for different elements or in different circumstances. This represents a departure from earlier frameworks that more strongly emphasized measurement consistency (IASB, 2018).

Current IASB projects signal further refinement rather than radical measurement paradigm shifts. The Goodwill and Impairment project explores enhanced disclosures about acquisition performance without fundamentally altering the mixed measurement approach to goodwill. Similarly, the Primary Financial Statements project focuses on presentation improvements rather than measurement revolutions, suggesting recognition that presentation clarity may be as important as measurement selection (IASB, 2023).

Implications for Financial Statement Users

The persistence of mixed measurement models requires financial statement users to develop sophisticated understanding of different measurement bases and their implications. Analysts increasingly focus on disaggregated information, separating operating performance from valuation effects to derive meaningful performance metrics.

Investment firm BlackRock exemplifies this approach in its equity analysis framework, which isolates fair value-driven volatility from core operating results when assessing management performance. Similarly, credit rating agency Moody’s adjusts reported financials to neutralize certain fair value effects when evaluating debt repayment capacity, focusing on cash flow sustainability rather than balance sheet valuations (BlackRock, 2023; Moody’s, 2023).

Education and disclosure quality become increasingly important in this environment. Companies with more transparent disclosure about measurement selections and their impacts typically receive valuation premiums, suggesting market rewards for reducing information processing costs. Danish pharmaceutical company Novo Nordisk, for instance, provides detailed sensitivity analyses showing how alternative measurement approaches would affect key financial metrics, enhancing analyst understanding without changing underlying measurements (Novo Nordisk, 2023).

Conclusion

The comparison of historical cost and fair value measurement bases reveals fundamental tensions in financial reporting that transcend technical accounting considerations. These approaches represent different philosophical perspectives on the purpose of accounting information—historical cost emphasizing stewardship and accountability for past transactions, fair value prioritizing decision usefulness and current economic reality.

The examples examined from diverse companies and industries demonstrate that measurement selection is contextually determined, influenced by asset characteristics, business models, cultural factors, and regulatory environments. Rather than converging on a single optimal measurement base, accounting practice has evolved toward nuanced application of different bases for different circumstances.

This analysis suggests several implications for accounting theory and practice. First, the dichotomy between historical cost and fair value increasingly appears artificial, with many practical applications incorporating elements of both approaches. Second, measurement base selection inevitably involves trade-offs between competing qualitative characteristics—particularly reliability and relevance—with optimal balance depending on specific circumstances and user needs. Third, disclosure quality and transparency about measurement selections may be as important as the selections themselves in enhancing financial statement usefulness.

Future research directions include examining how emerging technologies might reduce measurement costs and enhance reliability of fair value estimates, exploring behavioral implications of different measurement approaches on management decision-making, and investigating how measurement practices adapt to novel economic arrangements in the digital economy.

The ongoing evolution of measurement practices under international accounting standards reflects not merely technical refinement but continuous recalibration of fundamental accounting objectives in response to changing economic realities and user needs. This dynamic process ensures that financial reporting remains both anchored in reliable transaction evidence and responsive to current economic conditions—balancing past, present, and future informational demands.

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