ACCOUNTING THEORY

ACCOUNTING MEASUREMENT SYSTEM

Lecturer :
M.G Fitria Harjanti

Written by :
Ivan Hertanto / 141521400

UNIVERSITY OF ATMA JAYA YOGYAKARTA

FACULTY OF ECONOMICS
INTERNATIONAL FINANCIAL ACCOUNTING PROGRAM
2015
 Accounting Measurement System

Three Main Income and Capital Measurement Systems

1. Historical Cost Accounting

This system emerged after the 1929 Wall Street collapse

The main objective of historical cost is emphasizing on conservative (stewardship)

‘contractual’ relationship between a firm and those who provide resources to it by
making management accountable for the input of asset to operations and the
subsequent outputs on the net value of equity from operations. The key of
communication mechanism in this is the income statement itself.

In order to determine historical cost profit, the accounting entity must first retain the
same amount of capital from the beginning of the period (their purchase costs).
Income indicates the accomplishments of the firm for the given period, whereas
expenses represent the efforts expended, and profit correlates with the effectiveness
of the firm as an operating unit.

The historical cost accountant keeps track of the flow of costs, when the company
purchase goods and services, the accountant’s task is to trace the movement of cost
and match them to the revenues received as they flow through the business.

Important thing on conservative matching procedures are expenses should be

allocated as soon as possible, while revenues should not be recognized until there is
a high probability that they will be received. And then another borderland of
conservative matching procedures are increase in asset’s value should not be
recognized but decrease in value should be.

Arguments for historical cost accounting :

a. Historical cost is relevant in making economic decisions.
b. Historical cost is based on actual, not merely possible
c. Throughout history
d. The best understood concept of profit is the excess of selling price over
historical cost
e. Accountants must guard the integrity of their data against internal modifications
f. How useful is profit information based on current cost or exit price.
 Criticism of historical cost accounting:
a. Objective
b. Information for decision making
c. Basic of historical cost
d. Matching
e. Notions of investor needs

2. Current Cost Accounting

Objective of current cost accounting, create information to answer these question :
1. What amount of assets should be held at any particular time?
2. What should be the form of these assets
3. How should the assets be financed
Then used it for evaluation by managers of their past decisions in order to make the
best possible decisions for the future, and evaluation of managers by shareholders,
creditors, and others.
Current Cost Accounting 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 firm’s
resources to maximize future profits. Shareholders, investors and others are able to
make better allocations of their resources.
Managers will examine :
1. The current operating profit : the excess of the current value of the output sold
over the current cost of the related inputs
2. Realizable cost savings : Increases in the current cost of assets held, holding
gains/losses, realized / unrealized.
 Financial Capital versus Physical Capital :
Under market value accounting systems, the calculation of profit depends on the
measure of capital. That is, profit is more precisely defined as the change in capital
over the reporting period and not as an allocation of historical costs determined by a
multitude of accounting conventions. The main dispute between financial capital
and physical capital actually not revolves around the valuation concept, but the
definition of capital and how profit is measured from that definition. The main
differences is that whether or not holding gains (or losses) are included in profit. It
is included in profit under financial capital while it is excluded from profit under
physical capital
Arguments for and against Current Cost :
1. Recognition principle
2. Objectivity of current cost
3. Technological change
More specific criticisms over current cost accounting
1. Advocates of historic cost accounting
2. Comparisons of the results with historic cost
3. Advocates of exit price

3. Exit Price Accounting

Exit price accounting is a system of accounting which uses market selling prices to
measure the firm’s financial position and financial performance. It has 2 major
departures from conventional historical cost accounting :
1. The values of non-monetary assets are adjusted to measure changes in market
selling prices specific to those assets and they are included in income as
unrealized gains.
2. Changes in the general purchasing power of money are take into consideration
when measuring financial capital and the results of operations
It represents clean surplus accounting, the income statement explains all of the
differences existing between the opening and closing balance sheets.
Objective of exit price accounting is providing data for adaptive decision making, in
assumption that business world is dynamic and business must adapt to survive.
Firms and those associated with them go into markets to take advantage of
opportunities as they arise.

The ability to engage in market transactions is revealed by net financial position

(net current market value). Ultimately all accounting information users are
interested in cash and cash equivalent values. In the final analysis, the economic
survival and performance of a firm depends on the amount of cash it can command
Arguments for exit price accounting :
1. Providing useful information
2. Relevant and reliable information
3. Additivity
4. Allocation
5. Reality
6. Objectivity
7. A measure of risk
Arguments against exit price accounting :
1. Profit concept
2. Additivity
3. The valuation of liabilities
4. Current cost or exit price
Value In Use versus Value In Exchange

Both of them similar when markets are liquid and efficient, and there are some factors
common to both of them :
1. Market prices are more relevant for decision making
2. Additivity and reliability are prime requirements
3. Historic cost accounting has too many defects
They are complements (Can be used together) not substitutes, value in use assess long
term survival (solvency), while value in exchange assesses the ability to adapt in the
short term (liquidity).

A Global Perspective and International Financial Reporting Standards

Variants of current cost and price level accounting have been trialled or adopted in several
countries.
1. Current cost in the United States : started by SEC in 1976, they amended rule 3-17
of Regulation S-x to require that replacement cost data be disclosed in the filed 10
K-reports by firms with inventories and productive assets totaling more than
US$100 million and constituting more than 10% of total assets. Continued in 1979
by FASB, they repealed ASR 190 and issued Statement 33 requiring supplementary
disclosures of general inflation adjusted accounts and current cost data. Then those
practices ended in 1984 because those requirement to provide current cost data met
with tremendous resistance from companies.
2. Current cost in the United Kingdom : started in 1975, Standilands Committee which
is established by the UK Government, recommended a system of current cost
accounting. In 1985 after much debate, the ASC (Accounting Standards Committee)
withdrew the statement.
3. Current cost in Australia : started with issuance of Statement of Provisional
Accounting Standards Current Cost Accounting in 1976, that issued by the
accounting profession in that country. However due to criticisms lobbying by firms
and individuals and the lack of any material effect by the provisional standard on
reporting practices, a downgraded Statement of Accounting Practice about Current
Cost Accounting was issued in 1983
 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 arm’s length transaction. Historic cost accounting still generally
applied, distinct movement toward current value systems, IASB moving toward exit prices
(2004).

How is historic cost applied

Subjectivity is involved in the determination of the acquisition cost of an item.
Thereafter the measurements are even more subjective. Then the era of historic cost
accounting has ‘ended’, the reason is it produces irrelevant, unreliable, non-comparable and
non-understandable data.

A Mixed Measurement System and International Standards

Market value – exit prices are implied in the ‘fair value’ approach in international
financial reporting standards. A lack of theoretical concept of valuation, capital
maintenance and profit measure, has resulted in a still mixed measurement system and a
lack of consistency

Issues for Auditors

The mixed measurement model creates misstatement so that auditors struggle to
meet one of their primary objectives which is determining whether the financial statements
present a true and fair view.