Tip:
Highlight text to annotate it
X
Lets say i run some type of sheep farm or some type of wool producing business and in year one
i go out there and buy a bunch of sheep and i put them on some land and i go and buy the sheep for one million
dollars and i buy the land for 1.2 million dollars so we have 2.2 million dollars in assets.
Nothing confusing there .Now lets go to year two and think about how we want to account for the sheep
and the land
so one way we could say this the sheep are still there the land is still there
i paid a million dollars for the sheep and they are all still there so ill put on my books that the
sheep are still one million dollars and i paid 1.2 million dollars for the land
so ill put on my books that the landis one .two million dollars
so in this situation i have accounted for the sheep and the land based on their historical cost, so let
me write this down this is based on historical cost .Now another and this is a legitimate way to account
for things especially if theres no other way to really think about
what my sheep or my land are worth .Look this is what i paid for them now lets say there is an active
market in sheep and you can get a sheep apraiser to come over to your farm to come and tell you how
much you sheep are worth andyour sheep appriaser comes and says wow your sheep are looking good but
theresbeen a big, id dont know,sheep epidemic in another part of the country so there's a sheep shortage
so your sheep are actually worth a lot more that they were last year and they say i think you sheep
are now worth 2 million dollars .so you say Hey wow! the market value of my sheep is two million
so you could say instead of putting one million there let me put two million dollars for my sheep and
lets say the land is also appreciated the highways gone by and someone wants to build a development
nearby so theres the fair value of you land is also going up maybe its also two million dollars.
so both of theses so this is two million and this is two milllion so this right over here you could
view the market value or the fair value of your sheep. Now either one of these is legititmate ways of
accounting but its good to know the difference
This is historical cost accounting ,this is fair value accounting in general most accounting standard
board want people to report the fair value to market value as frequently as possible so its very easy to do if there
is kind of a market in that or you cannot get a apppraiser that can give you a pretty good estimate of what
these things are worth if that isnt around or if its just inefficient to do it then you probably want
to do the historical cost method so thats all the difference .Historial cost- how much yu paid for it
Fair value-whats the current market value today so it sound like very fancy words but its a pretty simple
idea