Group 8

Lolyta Destiana Simorangkir (20141112008)

Nadya Trinova (20141112010)
Devi Aryanti Siahaan (20141112075)
Class 3.03

Essay Questions
Measurement Theory
Week Five

35. Briefly outline the nominal, ordinal and ratio scales of measurement and explain why the
ratio scale is the one most commonly used by accountants. Include in your discussion an
example for each of the three scales.

a. Nominal scale
In the nominal scale, numbers are only used as labels. Examples of the nominal scale are
the numbering of football players, and in accounting, the classification of assets and liabilities
into different classes. The nominal scale simply represents classification, which is not what
measurement is.
b. Ordinal scale
Ordinal scale is created when an operation ranks the objects in question with respect to a
given property. For example, suppose an investor has three feasible investment opportunities
ranked 1, 2, 3 per their net present values, with 1 being the highest and 3 the lowest. The
operation gives rise to an ordinal scale, which indicates their profitability.
c. Ratio scale
The rank order of the objects or events with respect to a given property is known
The intervals between the objects are equal and are known
A unique origin, a natural zero point, exists where the distance from it for at least one
object is known.
Ratio scale is a scale most commonly used by accountants because it allows for all the
fundamental arithmetical operations. A ratio scale remains invariant (Fixed) over all
transformations when multiplied by a constant. Invariant in scale means that regardless of which
measurement method is used, the measurement system will yield the same format of all the
variables being used and therefore the decision maker will make the same decisions.
36. 'If all measurement except counting inherently involve errors then how can any statement

that includes a measurement be regarded as true'. J. Godfrey, et el, 'Accounting Theory', 7th Ed.
p.141
Discuss four sources of error in measurement giving an example related to accounting
measurement for each of the four sources you have discussed. Briefly explain how, in overall
terms, accountants deal with error in measurement.

a. Measurement operations stated imprecisely

The rule to assign numbers for a given property usually consists of a set of operations. A set of
operations may not be stated precisely and therefore may be interpreted incorrectly by the
measurer. For example, the calculation of profit involves numerous operations, such as cost
classifications and allocations between assets and expenses which are often interpreted
differently by different accountants
b. Measurer
The measurer may misinterpret the rule, be biased, or apply or read the instrument correctly. For
example, managers certain biases to increase the recorded profit or asset base and then place
pressure on the accountants to bias the accounts
c. Instrument
Many operations call for the use of a physical instrument, or other relevant tools such as a chart,
graph, or a price index. For instance, some consider the CPI for general price adjustments to be
defective.
d. Environment
The setting in which the measurement operation is performed can affect the result. One example
is the environment in which the firms management is operating in, in which the manager may be
paid their bonus according to the amount of profits earned
e. Attribute unclear
What is to be measured may not be clear, especially if the measurement involves a concept
which cannot be measured directly. For example, the mechanical ability of people which is not a
directly observable property
f. Risks and uncertainty
This relates to the distribution of returns on a tangible asset. For example, future returns on
tangible assets, such as plant and equipment are risky but they are homogenous and prices
observable.

If all measurements except counting inherently involves errors, then what we need is to establish
limits of acceptable error. If any measurement falls within these limits, then it can be considered
true and fair in accounting terms.

37. Discuss how the move away from historical cost towards fair value accounting may affect the
reliability and relevance of financial reports.

In the current environment of the corporate world, many experts have argued that financial
statements are irrelevant to financial analysts, considering the current techniques analysts use to
value the health and projected financial performance of an entity. The objective of fair value
accounting provides users of financial statements with a clearer picture of the current economic
state of a company, making a companys financial statements more relevant in the marketplace.
However, with the prevalence of fair value accounting and the move away from historical cost
generates a trade-off between reliability and relevance. Many experts have questioned the
reliability of fair value methods, due to the subjectivity and estimation process which relies on an
accountants professional judgment.

38. 'when profit is derived from changes in fair values more difficult questions arise for the

auditor ' J. Godfrey, et el, 'Accounting Theory', 7 th Ed. p.150.

Discuss the implications for auditors of the shift in the focus of profit measurement from
matching revenues and expenses to assessing changes in the fair value of the net assets.

When profit is determined by matching revenue and expense transactions for the period the
auditor can concentrate on gathering evidence that those transactions have been handled
appropriately by the clients accounting system. However, when profit is derived from changes in
fair values, more difficult questions arise for the auditor around gathering evidence on
managements estimates. Auditors are required to gather evidence to judge if management has
followed the accounting standard appropriately and if the amount recognised as an impairment
loss is recognisable. To do this, the auditor must determine whether management has chosen
appropriate and reasonable valuation methods and assumptions. If the accounting standards do
not prescribe the valuation method for the particular assets and liabilities being considered, the
auditor could accept any reasonable valuation method. Auditor must gather evidence that the
method is applied consistently, so managers do not pick and choose methods from year to year
depending on their desired profit result. Auditors must also assess whether the asset or liability
values are properly determined from managements significant assumptions, the valuation model
and relevant underlying data. Such data would include the interest rates used for discounting
cash flows, market values used by comparison companies, and so on.