Difference between Historical Cost and Fair Value

There are two methods to calculate the value of fixed assets of company. One is value of fixed assets on the basis of historical cost and other is on the basis of fair value. But there are many differences between historical cost and fair value. We can explain it with some examples:

Example No. 1 :

Historical Cost Vs Fair Value
Suppose, I have bought my new computer in previous year 2010 and it was bought at 555$. If I calculate my computer’s value at historical cost, then my computer’s value will be 555$ in 2011 as same as previous year. 555$ is the historical cost of my computer. To calculate historical cost is very easy because real purchase price of fixed asset or value of fixed assets which is shown in the books of company, will be historical cost. When I went to market, I found that same computer’s value depreciated to 250 $ due to decreasing the sales prices of computer and high import of parts of computer from China at very low cost. 250$ is the fair value of my computer.

From Above Example, we learn Two Things :

First : Historical Cost remains always same.

Second : Fair Value is the Market Price of Any Asset.

 Example No. 2

We need to know fair value for investment decisions instead of historical cost because fair value is the current market value of fixed assets. Suppose, you invested $ 10,000 in A, B and C as long term investment in 2006. But now, you want to sell it and want to buy new. Company A may develop and B and C may face loss. Due to this, your total investment in shares of $ 10,000 may be $ 6000 in 2011. We can only sell our investment on fair value. But same rule will not apply on computer because investment in share market never become second hand but computer becomes second hand and saleable value of same computer may of $ 125. First of buyer will calculate computer’s fair market value and then deduct 50% from it for paying me.

We also remember that some asset’s fair value may appreciate but there will never any change in historical cost of asset.

From above example, we learn Two Things:

First : Fair Value may effect different assets different ways. But historical cost never effect its book value.

Second : For calculate of fair market value of any asset, depreciation may be deducted or not as per the nature of asset.

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Accounting Education: Difference between Historical Cost and Fair Value
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