The modified historical cost convention

IFRS requires financial statements to be prepared on the modified historical cost convention basis, with a growing emphasis on fair value. ‘Fair value’ is 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 – i.e. an exit price. [IFRS 13 9]

The carrying amounts of the following assets and liabilities are based on fair value measurements subsequent to initial recognition.

  • Derivatives, financial assets, and financial liabilities classified as held-for-trading or designated as at fair value through profit or loss, and financial assets classified as available-for-sale are measured at fair value. The modified historical cost convention
  • Biological assets are measured at fair value less costs to sell. The modified historical cost convention The modified historical cost convention
  • In general, an investment entity measures investments in subsidiaries at fair value. The modified historical cost convention
  • Whole classes of property, plant, and equipment may be revalued to fair value subject to certain conditions.
  • Certain intangible assets may be revalued to fair value. The modified historical cost convention
  • Investment property may be measured at fair value. The modified historical cost convention
  • Inventories held by commodity broker-traders may be measured at fair value less costs to sell.

Additionally, discounting and value-based measurements are an integral part of financial reporting under IFRS in some areas, including impairment testing and provisions.

How is fair value accounting used in IFRS?

Three notions of fair value accounting enter the discussion, and one must be clear on what is being entertained: The modified historical cost convention

1. Fair value variously applied as an alternative measurement in a “mixed attribute model”

This is the modified historical cost convention described in IFRS 13 as per above. In this treatment, fair value is used alternatively with historical cost for the same asset or liability but at different times; the accounting is primarily historical cost accounting, but fair values are applied under certain circumstances. Examples are fair values applied in fresh-start accounting and for initial measurement (that then proceeds under historical cost accounting), impairment from historical cost to fair value (really a form of fresh start accounting), and using fair values to establish historical cost (for barter transactions and donations, for example) or in the allocation of historical purchase price (between goodwill and tangible assets, for example).

2. Fair value continually applied as entry value

This is rejected by IFRS 13. Assets are revalued at their replacement cost, with current costs then recorded in the income statement and unrealized (holding) gains and losses also recognized in (comprehensive) income. The modified historical cost convention

3. Fair value continually applied as exit value

This is the fair value measurement approach prescribed by IFRS 13. Assets and liabilities are remarked each period to current exit price, with unrealized gains and losses from the remarking recorded as part of ‘profit or loss’ or ‘other comprehensive income’. The modified historical cost convention

Key definitions IFRS 13 Fair value measurement

[IFRS 13:Appendix A]

Fair value – 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

Active market – A market in which transactions for the asset or liability take place with sufficient frequency and volume to provide pricing information on an ongoing basis

Exit price – The price that would be received to sell an asset or paid to transfer a liability
Highest and best use – The use of a non-financial asset by market participants that would maximise the value of the asset or the group of assets and liabilities (e.g. a business) within which the asset would be used
Most advantageous market – The market that maximises the amount that would be received to sell the asset or minimises the amount that would be paid to transfer the liability, after taking into account transaction costs and transport costs
Principal market – The market with the greatest volume and level of activity for the asset or liability

The modified historical cost convention The modified historical cost convention The modified historical cost convention The modified historical cost convention

The modified historical cost convention

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