Chapter 4

Measurement

PowerPoint Presentation
by Matthew Tilling
©2012 John Wiley & Sons Australia Ltd
 Measurement In Accounting
• Conceptual framework definition:
the process of determining the monetary amounts
at which the elements of the financial statements
are to be recognised and carried in the balance
sheet and income statement.
• May involve calculation, estimation, and/or
apportionment.
• Impacts quality and therefore usefulness
 Benefits of Measurement
1. Makes financial statements decision useful
– Gives meaning to the items included
Allows users of accounting information to:
2. Assess an entity’s financial performance and
position
3. Compare the entity’s performance and
position over time.
4. Compare entities
 Limitations of Measurement
1. Little or no agreement on what measures should
be used.
2. The inherent flexibility and the nature of a
mixed measurement approach reduces
comparability.
3. Measurement can be quite subjective.
4. With flexibility comes opportunistic accounting
choices.
5. The current approach results in the additivity
problem.
 Measurement Approaches And
Accounting Standards
• The Conceptual Framework does not provide
guidance as to which measurement bases
should be used
• In reality a range of bases are used
• Historic cost remains dominant
• Steady shift towards fair value
 Historical Cost
Defined in the Conceptual Framework as:
Assets are recorded at the amount of cash or cash
equivalents paid or the fair value of consideration
given to acquire them at the time of their
acquisition. Liabilities are recorded at the amount
of proceeds received in exchange for the
obligation, or in some circumstances (for example,
income taxes), at the amounts of cash or cash
equivalents expected to be paid to satisfy the
liability in the normal course of business.
Current Cost — Replacement Cost
Defined in the Conceptual Framework as:
Assets are carried at the amount of cash or cash
equivalents that would have to be paid if the same
or an equivalent asset was acquired currently.
Liabilities are carried at the undiscounted amount
of cash or cash equivalents that would be required
to settle the obligation currently.
 Fair Value —
Realisable or Settlement Value
Defined in the Conceptual Framework as:
Assets are carried at the amount of cash or cash
equivalents that could currently be obtained by
selling the asset in an orderly disposal. Liabilities
are carried at their settlement values; that is, the
undiscounted amounts of cash or cash equivalents
expected to be paid to satisfy the liabilities in the
normal course of business.
 Present Value
Defined in the Conceptual Framework as:
– Assets are carried at the present discounted value
of the future net cash in flows that the item is
expected to generate in the normal course of
business. Liabilities are carried at the present
discounted value of the future net cash out flows
that are expected to be required to settle
liabilities in the normal course of business.
 Deprival Value
• Essentially the loss that would be suffered if
an entity was deprived of the asset.
• Determination of the deprival value of an
asset may incorporate:
– present value if the item was held for use
– net realisable value if the item was held for sale
– replacement cost associated with replacing the
item or the services that were received from the
item.
 Measurement and International
Accounting Standards
• IASBs use a mixed measurement model
different measurement bases are employed to
different degrees and in varying combinations
during the preparation of the financial statements.
• This leaves a large amount of flexibility and
choice within particular standards
Measurement and International
Accounting Standards
Measurement and International
Accounting Standards
Measurement and International
Accounting Standards
 Future Directions
on Measurement
• Measurement is an important part of the IASB
Conceptual Framework Project
• Approaches tentatively considered:
– Actual or estimated current prices
– Actual past entry prices with adjustment
– Prescribed computations or calculations based on
discounted or undiscounted estimates of future
cash flows
 Decision criteria and influences on
choice of measurement approach
• Significant influences include:
– Potential users of the financial statements
• What will provide the most decision useful information
– Practical considerations
• Is it possible to calculate
• Cost versus benefit
– Managements motivations and objectives
• Short-term versus long-term
• Impact on incentives
• Reputational impact
 Measurement And The Quality Of
Accounting Information
• Measurement choices impact
– Relevance
– Faithful Representation
– Understandability
– Comparability
– Verifiability
 Historic Cost
• Relevance
– Low: Especially as time passes
• Faithful Representation
– High: Measures an objective transaction
• Understandability
– High: Concept well known and understood
• Comparability
– Medium: Purchasing power of money changes
 Current Cost
• Relevance
– High: Indicative of future potential
• Faithful Representation
– High: Determined by reference to actual costs
• Understandability
– Low: Can be subjective, depends
• Comparability
– Medium: Can be subjective, depends
 Present Value
• Relevance
– High: Indicative of future potential
• Faithful Representation
– Low: Can be very subjective
• Understandability
– Medium: Assumptions used can be complex
• Comparability
– Medium: Involves many different assumptions
 Deprival Value
• Relevance
– Low: Not related to business case
• Faithful Representation
– Low: Can be very subjective
• Understandability
– Low: Assumptions used can be complex
• Comparability
– Low: Involves many different assumptions
 Fair Value
• There appears to have been a distinct move
from historical cost to fair value accounting.
• Valuation Methods
– Market Approach
– Cost Approach
– Income Approach
• Current standard discussed in detail in
Chapter 10
 Arguments for Fair Value
• Relevance
– Focuses on future potential
• Faithful Representation
– Determined using objective market prices
• Understandability
– Simply representation of current market value
• Comparability
– Focus on market value not individual entity
 Arguments Against Fair Value
• Relevance
– Hypothetical and not relevant to specific entity
• Faithful Representation
– If no objective market prices then highly subjective
• Understandability
– Often based on complex assumptions and calculation
• Comparability
– Different models lead to very different results
 Stakeholders And The Political Nature Of
Accounting Measurement
• Users have different and sometimes
conflicting needs when it comes to accounting
information.
• The impact and relevance of measurement to
investors and other users of the financial
statements is obvious.
– What do users really need to know?
– How do users influence the measurement
approach?
Existing and Potential Investors
• Concerned with the risk inherent in, and the
return provided by, their investments.
• They want accounting information that:
– Assists them in deciding whether to buy, hold, or
sell their shares.
– Enables them to assess the entity’s ability to pay
dividends.
• Therefore need forward looking information
– Fair Value?
 Creditors/Lenders
• Interested in information that enables them to
determine whether amounts owing to them
will be paid when due.
• Particularly interested in the entity’s net
position
– Liabilities it has compared to its assets.
• Fair value would seem to be the most useful
approach, assuming that items can be reliably
measured.
 The Political Nature of
Accounting Measurement
• Different interest groups may favour different
accounting measurement approaches.
• Fair value has been particular focus during the
GFC.
– May have made economic crisis worse
– May not be reliable
– May have hidden problems
– May be difficult to regulate
Why Measurement Is A Controversial
Accounting Issue
• Inappropriate choices of method.
– Tension between flexibility and potential to
mislead
• Variability in practice
– Tradition has led to difference
• Subjectivity involved
• Impact of measurement on organisation
– Short/long term impact on profit
Current Measurement Challenges
• Green assets and other sustainability issues
– What needs to be measured and accounted for?
– How can the discretion and subjectivity associated
with the estimation of values be managed?
– What are the consequences associated with
accounting for social and environmental aspects
of the entity?
Current Measurement Challenges
• Intangible Assets
– Complexity and variation exists in terms of how
intangible assets are measured on recognition
Current Measurement Challenges
• Water Assets
– Water accounting standards are being developed
in several countries, with no single body taking
responsibility for international standards
– Measurement and Valuation
• Wide range of stakeholders
• How should value be determined
• Water quality and recognition
– Water is a limited natural resource which needs to
be managed, measured and reported.
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