Campbell:

The assignment of numerals to represent

properties of material systems other than
numbers

Assignment of numerals to objects or events

according to rules.
(Stevens)
2

Involves linking the formal number system to

some property of objects or events by means
of semantic rules
e.g. semantic rules in accounting are represented
by transactions

In accounting we measure profit by:

first assigning a value to capital
then calculating profit as the change in capital over
the period

We examine the relationship between the fair value measurement and the
audit quality. Our evidence suggests that the fair value measurement has a
negative impact on the overall CPAs audit quality. And this negative effect
depends on the application scale of the fair value measurement. Nowadays,
large-scale application of the fair value measurement does decrease the
overall audit quality, but a modest application reflects the intention of
improving the value relevance of accounting information and plays its proper
role.
They should pay more attention to the audit of fair value and reduce the
adverse effect of fair value measurement on external audit, so that this
measurement can play its proper role as soon as possible.

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Greater Use of Current Values in the Financial

Statements Proper
Two versions of current value
Exit price: SFAS 157 defines fair value as exit price
Value-in-use: present value of future cash receipts or
payments

Role of measurement approach is to increase

decision usefulness over that of information
approach

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Securities markets may not be as efficient

as previously believed
To extent markets not fully efficient, a
measurement perspective is supported

Low R2

Better measurement may increase accounting

market share in explaining share price changes

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Ohlsns clean surplus theory

A theoretical framework supportive of a
measurement approach

Auditor Liability
Better measurement may reduce auditor liability
when firms become financially distressed

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Behavioural finance
Behavioural characteristics that question market
efficiency

Limited attention
Overconfidence
Representativeness
Self-attribution bias

Leading to momentum

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Every measurement is made on a scale

Created when a semantic rule is used to
relate the mathematical statement to objects
or events
The scale shows what information the
numbers represent

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Nominal scales
Number used only for labels;
Numbers represent classifications;
e.g. the classification of assets and liabilities into
different classes

Ordinal scales
Rank orders objects with respect to a given
property
Intervals between the numbers are not
necessarily equal

12

Interval scale

Rank orders objects with respect to a given

property
The distance between each interval is equal and
known
An arbitrarily selected zero point exists on the scale
e.g. celsius temperature scale
e.g. standard cost accounting

Ratio scale

Rank orders objects with respect to a given

property
Intervals between objects are known and equal

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RATIO SCALE

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15

Invariance of a scale means that the

measurement system will provide the same
general form of the variables, and the
decision maker will make the same decisions
This is not the case in accounting there is
more than one accounting system
The information they provide will differ and
different decisions will be made

16

There must be a rule to assign numbers

before there can be measurement
The formulation of the rules gives rise to a
scale
Measurement can be made only on a scale

17

Numbers are assigned by reference to natural

laws
Fundamental properties are additive
e.g. length, number and volume

In accounting there is considerable debate

over the nature of fundamental value

18

Is one that depends on the measurement of

two or more other quantities
Depends on known relationships to
fundamental properties
e.g. the measurement of density depends on the
measurement of both mass and volume
e.g. the measurement of profit depends on the
measurement of both income and expenses

19

Typical in social sciences including

accounting
Based on arbitrary definitions - e.g. of profit
Numerous ways in which scales can be
constructed
May lead to poor levels of confidence in the
scale e.g. there are hundreds of ways to
measure profit

20

No measurement is free of error except

counting
e.g. we can count the chairs in a room and be
exactly correct

21

What is reliable measurement?

proven consistency
repeatable or reproducible
precision

Reliability incorporates two aspects

accuracy and certainty of measurement
representative faithfulness

22

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23

Consistency of results, precision and

reliability do not necessarily lead to accuracy
Accuracy has to do with how close the
measurement is to the true value of the
attribute measure - representation
True value may not be known
e.g. in accounting accuracy relates to the pragmatic
notion of usefulness

24

Many accounting measurements are on a

ratio scale
This is the most informative scale
Weakest theoretical foundation as they are
fiat measurements

25

The sources of error include the following:

Measurement operations stated imprecisely
Measurer
Instrument
Environment
Attribute unclear
Risk and uncertainty

We need to establish limits of acceptable error

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Two fundamental measures

capital & profit

Capital and profit can be defined & derived in

various ways
Concepts of capital & profit have changed
over time
number of concepts of fundamental measurement

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Two notable developments in international

standards (2005, IASB)
profit measurement and revenue recognition should
be linked to timely recognition
the fair value approach should be adopted as the
working measurement principle

At no stage has the principle of capital maintenance

been explicitly discussed

30

The focus of profit measurement has shifted

from matching revenues and expenses to
assessing the changes in the fair value of net
assets
e.g. immediate recognition of impairment losses

Auditors must determine whether

management has made appropriate and
reasonable valuations
e.g. at least 12 methods of valuing intangibles

31

It is possible for several different but

reasonable measurements and impairment
losses to be recognised by management
These would all be acceptable to an auditor if
management have

applied the valuation models correctly

used appropriate data
made appropriate assumptions
acted in a consistent manner

32

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33

The historic cost accounting system

current cost accounting

34

Separation of ownership and control

information asymmetry

Most critical objective of accounting is

accountability - stewardship (conservatism)
The income statement is paramount

transaction based
revenue recognition
matching
profit measurement

35

Relevant in making economic decisions

Based on actual, not merely possible, transactions
Data have been concept of profit
Must guard data against internal
modificationsfound to be useful
The best understood
Profit based on alternatives may not be useful
Market prices can be supplementary data
Insufficient evidence to reject it

36

Objective of accounting
Information for decision making
Basis of historic cost
Matching
Notions of investor needs

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CCA values assets at their current market buying price

and profit is determined using matching expense
allocations based on the current cost to buy
Profit is more precisely defined as the change in capital
over the accounting period
Managers are better able to evaluate their past
decisions and better use the firms resources to
maximise future profits
Shareholders, investors and others are able to make
better allocations of their resources
Managers will examine

38

Recognition principle
violates the conservatism principle - but actual
phenomena
are holding gains profits or revaluation
adjustments?

Objectivity of current cost

lacks objectivity

Technological change
appears to ignore technological advances

39

IASB/FASB have agreed that fair value is the

best measurement basis (2004)
the amount for which an asset could be
exchanged, or a liability settled, between
knowledgeable, willing parties in an arms length
transaction

40

Market values - exit prices - are implied in

the fair value approach in international
financial reporting standards
A lack of a theoretical concept of valuation,
capital maintenance and profit measure, has
resulted in a still mixed measurement system
and a lack of consistency

41

The mixed measurement model creates

misstatement so that auditors struggle to
meet one of their primary objectives
determining whether the financial statements
present a true and fair view

42

Will a measurement approach reduce auditor

liability?
Perhaps, if investors subject to limited attention

Auditor can claim that the financial statements proper

anticipated value changes

But, current values may be subject to manager

bias if no market value available
Then, may be hard to resist manager bias

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Example: conditional conservatism

A change in asset value has already occurred

Assume investor is risk averse
Investor opportunity loss of expected utility if a
decline in asset value is not recorded = 1.02
Investor loss if an increase in asset value not
recorded = .52
Investor more likely to sue auditor if a decline in
asset value not recorded.
Auditor reaction: conservative accounting, to reduce
likelihood of lawsuit
Continued
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Example: unconditional conservatism

Asset value = $10,000 at financial statement date, but
value may change in future
If asset declines in value, investor loses utility of 1.02
If asset increases in value, investor loses utility of .54

How should auditor value asset at statement date?

If asset valued at $10,000 (current value), investor
expected utility = 39.93
If asset valued at $9,400 (conservative valuation),
investor expected utility = 40.00

This suggests an investor demand for conservatism

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Assuming reasonable reliability, current value

accounting can increase decision usefulness
relative to information perspective
Increased use of current value accounting in
financial reporting
Reasons

Markets not fully efficient

Low explanatory power of net income for share returns
Ohlsn clean surplus theory
Auditor liability

Decision usefulness for investors may be further

increased by conservative accounting
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