Academy of Accounting and Financial Studies Journal (Print ISSN: 1096-3685; Online ISSN: 1528-2635)


Can The Switch From Fair Value Method To Cost Method For Plant Asset Valuation Be Justified?

Author(s): Chengjie Dong, Zhijun Lin, Jinsong Tan, Zhemin Wang

International Accounting Standards (IAS) No. 16 allows companies to use either the fair value method or the cost method for plant asset valuation. Once an entity selects one of the two methods, a switch is permitted only if it results in a more appropriate valuation, which, according to the International Accounting Standards Board (IASB), is highly unlikely for a switch from the fair value method to the cost method. Using a sample of firms that adopted IAS No.16’s fair value method, we document significant evidence indicating that investors discount plant assets measured at fair value. Furthermore, investors also discount fair value firms’ other assets and liabilities. Finally, when fair value firms switch to the cost method, the value relevance of their accounting amounts improves significantly. Taken together, the evidence is consistent with the view that investors perceive the fair value of plant assets to be less reliable and, thus, place less weight on it in equity valuation. In addition, the improved value relevance in the post-switch period justifies the switch by many fair value firms to the cost method.

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