CIA3003:

 Accounting  Theory  and  Practice  

Accounting  measurement  theory  and  systems  
Semester  2,  20192010  
Learning  objectives  
A"er  studying  this  presenta1on,  you  should  be  able  to:  
o Understand  the  concept  of  measurement  in  the  current  context  of  
financial  repor5ng  and  evaluate  its  many  benefits  and  limita5ons  
o Evaluate  different    measurement  approaches  
o Understand  the  impact  of  measurement  choice  on  the  quality  of  
accoun5ng  informa5on.  
o Understand  the  controversial  nature    of  fair  value  as  a  measurement  
approach  and  consider  the  arguments  for  and  against  a  shi>  toward  
fair  value  under  the  accoun5ng  standards  
 
Measurement  in  accounting  
• Measurement  is  the  act  or  system  of  measuring.  
• Paragraph  4.54  of  the  Conceptual  Framework  for  Financial  
Repor4ng  (Conceptual  Framework):    
• 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.  
• Measurement  in  an  accoun5ng  context  therefore  refers  to  the  
way  the  figures  on  the  financial  statements  are  determined.  
Measurement  in  accounting  
• Benefits  of  measurement:  
• It  assists  in  making  financial  statements  decision  useful.  
• Allows  users  to  assess  the  financial  performance  and  financial  
posi5on  of  the  en5ty.  
• Allows  users  to  compare  the  en5ty’s  performance  and  posi5on  over  
5me.  
• Allows  users  to  compare  en55es.  
Measurement  in  accounting  
• Key  limita1ons  of  measurement  in  accoun1ng:  
• Li?le  or  no  agreement  on  what  measures  should  be  used.  
o Choice  is  allowed  even  within  individual  standards  
• The  inherent    flexibility  and  the  nature  of  a  mixed  measurement  
approach  reduces  comparability.  
o Can  meaning  be  derived  from  comparing  two  en55es  that  have  similar  
items  but  choose  different  methods  to  measure  them?  
• With  flexibility  comes  opportunis1c  accoun1ng  choices.  
• The  current  approach  to  measurement  results  in  the  addi1vity  
problem.  
• Total  assets  can  consist  of  assets  measured  using  historical  costs,  fair  
value  
Measurement  approaches    
and  the  accounting  standards  
• Measurement  approaches:  
• The  Conceptual  Framework  outlines  factors  to  consider  when  
selec1ng  a  measurement  base  
• recognises  that  in  most  cases,  no  single  factor  will  determine  which  
measurement  bases  will  be  selected  
• Historic  cost  is  the  most  dominant  measurement  base  used  by  
en55es.  
Measurement  approaches    
and  the  accounting  standards  
• Historical  cost:  
• Dominant  measurement  approach.  
• Tradi5onal  historical  cost  essen5ally  requires  items  to  be  
recorded  at  the  amount  at  which:    
• they  were  purchased    
• or    they  were  received.  
• Transac5ons  are  based  on  the  past.  
Measurement  approaches  and  the  accounting  
standards  
• Current  cost  —  replacement  cost:  
• Costs  incurred  to  replace  items.  
• Current  costs  and  replacement  costs  are  o>en  used  interchangeably  
• However,  they  represent  two  different  methods  of  measuring  the  
cost  of  replacing  items  
• Current  cost:    
• an  item  is  valued  and  recorded  at  the  amount  that  would  be  paid  at  the  
current  1me  to  provide  or  replace  the  future  economic  benefits  
expected  to  be  derived  from  the  current  item.    
• Replacement  cost:    
• an  item  is  valued  and  recorded  at  the  amount  that  would  be  paid  at  the  
current  5me  to  purchase  an  iden1cal  item.  
• Current  cost  is  broader,  represents  costs  incurred  to  obtain  the  same  
expected  future  economic  benefits  that  would  be  received  from  
current  item,  which  may  be  achieved  in  different  ways,  not  
necessarily  through  purchase  of  iden1cal  item  
Measurement  approaches  and  the  accounting  
standards  
• Fair  value  —  realisable  or  se?lement  value:  
• Becoming  more  popular  due  to  the  release  of  AASB  13/IFRS  13  
Fair  Value  Measurement.  
• Considered  more  relevant  from  a  decision  usefulness  perspec5ve.  
• Fair  value:  
• the  price  that  would  be  received  to  sell  an  asset  or  paid  to  transfer  a  
liability  in  an  orderly  transac5on  between  market  par5cipants  at  the  
measurement  date.  
• Fair  value  is  exit  value,  value  or  amount  that  en5ty  derive  by  
selling  an  item    
• It  represents  market  value  of  an  item  
Measurement  approaches  and  the  accounting  
standards  
• Fair  value  —  realisable  or  se?lement  value:  
• Realisable  value:  
• An  exit  value  represen5ng  the  amount  expected  to  be  received  upon  
disposal  of  an  asset.  
• Concept  of  fair  value  and  realisable  value  similar  
o However,  fair  value  is  more  complex  
o It  is  a  theore5cal  es5ma5on  of  the  market  value  of  an  item  
o Realisable  value  is  en5ty  specific  but  fair  value  is  a  market  based  
measure  
• Present  value:  
• Subjec5ve  measurement  approach  and  involves  uncertainty.  
• Takes  the  cash  flows  expected  to  be  received  in  the  future  and  
reduces  them  so  that  they  reflect  their  value  today.  
Measurement  approaches  and  the  accounting  
standards  

• Interna1onal  accoun1ng  standards:  

• Standard   se[ers   u5lises   different   measurement   bases  
throughout  the  prepara5on  of  financial  statements    
• Referred  to  as  a  mixed  measurement  model.  
• The   main   reason   for   adop5ng   such   an   approach   is   the   need   for  
flexibility.    
• This   model   allows   for   use   of   a   number   of   different   measurement  
bases.    
• This  is  necessary  due  to  the  differences  in:  
•  the  substance  or  nature  of  transac5ons  between  en55es  and  
•  also  due  to  the  differing  circumstances  that  en55es  can  find  themselves  
in.    
Measurement  approaches  and  the  accounting  
standards  

• Interna1onal  accoun1ng  standards:  

• Mixed  model  measurement  leads  to:  
•  varia1ons  in  accoun1ng  prac1ce    
• en55es  may  choose  to  account  for  the  same  or  similar  items  in  different  
ways  using  different  measurement  methods.  How  they  measure  and  
account  for  an  item  may  be  appropriate  for  the  individual  en5ty  but  could  
reduce  comparability  across  en55es.  
• Poten5al  for  different  financial  results  being  reported  when  
different  measurement  methods  are  allowed  and  used    
• Discre1on  means  opportunity  for  management  to  make  
opportunis5c  accoun5ng  choices,  crea5ng  a  biased  picture  of  reality  
and  perhaps  even  misleading  users      
Measurement  approaches  and  the  accounting  standards  
Factors  that  inEluence  the  choice  of  measurement  
approach  
• One  of  the  most  prominent  influences  on  accoun5ng  policy  
choice  lies  in  the  purpose  for  which  financial  statements  are  
being  prepared  
• In  order  to  determine  which  measurement  base  is  most  
appropriate,  factors  to  consider  include:  
• poten5al  users  of  the  financial  statement  
• Does  it  affect  decision  usefulness  
• prac5cal  considera5ons  
• A  par5cular  cost/value  may  be  too  difficult/expensive/costly  to  obtain  
• management’s  mo5va5ons  and  objec5ves.  
• If  management  has  a  short  term  focus  (short  term  contract/bonus  5ed  to  
current  year’s  profits)-­‐most  likely  to  choose  measurement  approach  
which  produces  the  best  result  in  terms  of  higher  profits  
Measurement  and  the  quality  of  accounting  
information  
• Measurement  choices  impact:  
o relevance  
o faithful  representa5on  
o understandability  
o comparability  
o verifiability.  
Measurement  and  the  quality  of  
 accounting  information  
• Historical  cost:  
• Less  relevant,  as  it  is  not  necessarily  reflec5ve  of  the  value  of  benefits  
(present  and  future).  
o What  an  en5ty  paid  for  item  in  past  is  not  reflec5ve  of  value/benefit  of  
item  now  and  in  the  future  
• Produces  informa5on  which  is  more  faithfully  represented.  
o More  neutral  as  there  is  very  li[le  or  no  es5ma5on  involved.  
o Values  can  be  traced  back  to  transac5on  documenta5on  
• Informa5on  produced  is  generally  understandable,  
• However  historical  costs  but  may  less  comparable.  
o Different  items  are  purchased  on  different  dates  and  in  different  year  
o Purchasing  power  of  money  changes,  amounts  paid  in  different  years  
cannot  really  be  compared  
o Two  en55es,  one  with  older  assets,  one  with  newer  assets,  is  it  appropriate  
to  compare  net  assets?  
Measurement  and  the  quality  of  
 accounting  information  
• Fair  value:  
• Informa5on  produced  using  fair  value  as  the  measurement  base  is  argued  
to  be  more  relevant  as  reflects  what  items  are  worth  now  rather  than  
what  they  were  worth  when  purchased.  
• The  quoted  market  price  for  an  item  is  an  objec5ve  method  for  
determining  the  fair  value  of  an  item  and  is  more  faithfully  represented.  
o However,  if  no  ac5ve  market,  forming  a  theore5cal  es5mate  of  the  current  
market  value  involves  assump5ons  and  professional  judgements.  
• Informa5on  produced  using  fair  value  is  viewed  as  being  more  
understandable  
o User  perspec5ve  easy  to  understand  as  fair  value  equivalent  to  market  value  of  
item  
•  More  comparable  (arguably).  
o All  values  are  current  and  measured  on  same  date  
o However,  due  to  varia5on  which  can  exist  in  the  valua5on  techniques  adopted  
to  measure  fair  value,  informa5on  is  less  comparable  
Measurement  and  the  quality  of  
 accounting  information  
• Current  cost:  
• Informa5on  is  more  relevant  than  the  use  of  historical  cost  as  it  reflects  
what  would  be  paid  for  same  item  today  
• Faithfully  represented  informa5on  due  to  the  use  of  actual  current  cost.  
• However,  current  cost  is  more  complex(less  understandable)  that  other  
measurement  approaches  
• In  reality,  unlikely  to  buy  an  equivalent  item,  as  item  may  be  no  longer  be  
available  and  technology  is  constantly  changing  
• Values  may  be  more  comparable  in  the  sense  that  costs  should  always  
reflect  the  amount  to  be  paid  now  to  receive  same  future  economic  
benefit,    
• However,  due  to  to  the  variability  which  exists  in  terms  of  how  an  en5ty  may  
chose  to  achieve  the  same  economic  benefits,  it  may  be  less  comparable.  
Measurement  and  the  quality  of  accounting  
information  
• Present  value:  
• Values  are  more  relevant  as  users  are  interested  in  the  value  or  
net  worth  of  an  en5ty  
o Present  value  provides  an  es5mate  of  he  present  value  of  future  
cash  flows  expected  to  be  derived  from  an  item  
• Due  to  the  es5ma5on  involved,  assump5ons  and  judgement  the  
approach  lacks  faithful  representa1on  and  neutral  depic1on.    
• Less  understandable  as  approach  involves  complex  es5ma5ons  
and  formulas.  
• Comparable  (arguably)  as  amounts  are  discounted  to  the  present  
day  and  in  current  dollars.  
Fair  value  
• Recently,  there  has  been  a  dis5nct  move  from  historical-­‐cost  to  fair-­‐
value  accoun5ng  
• MFRS  13  allow  for  a  number  of  different  valua5on  technique  
depending  on  circumstance  and  nature  of  item  
• Valua1on  methods:  
• Market  approach:  
• Observable  market  prices  and  informa5on  generated  by  market  
transac5ons.  
• Cost  approach:  
• In  some  circumstances,  cost  may  be  the  best  indicator  of  current  market  
value  
• Cost  reflects  the  current  amount  required  to  replace  the  service  capacity  
of  an  asset  ie:  how  much  it  would  cost  to  acquire  an  asset  now  that  
would  achieve  the  same  service  capacity  provided  by  the  asset  that  we  
are  a[emp5ng  to  value  
• Income  approach:  
• Approxima5on  of  current  market  value  is  made  by  es5ma5ng  the  future  
cash  flows.  
Fair  value  
• Arguments  for  fair  value:  
• More  relevant  as  it  reflects  current  market  prices.  
• Faithfully  represents  reality  where  other  measurement  approaches  
cannot.  
• Neutral  depic1on  as  fair  values  are  primarily  determined  using  
objec5ve  market  prices.  
• More  comparable  as  the  current  value  at  the  same  point  in  5me  is  
represented.  
• Understandable  as  it  is  simple  and  straigh`orward.  
• Arguments  against  fair  value:  
• Amount  of  subjec1vity  and  judgement  involved  in  forming  
es5ma5ons  of  market  value  in  the  absence  of  an  objec5ve  market  
price.  
• Less  faithfully  represented  due  to  the  subjec5ve  nature  of    the  
valua5on  process.  
• The  most  controversial  measurement  approach  due  to  the  
subjec5ve  nature  of  es5mates  involved  in  determining  fair  value  
when  no  ac5ve  market  exists  for  an  item  
Stakeholders  and  the  political  nature    
of  accounting  measurement  
• Financial  statements  are  used  to  sa5sfy  different  needs  for  
informa5on.  
• Users  have  different  and  some5mes  conflic5ng  needs  when  it  
comes  to  accoun5ng  informa5on.  
• Measurement  choices  have  an  impact  on  the  quality  of  
accoun5ng  informa5on  produced  via  the  financial  statements.  
Stakeholders  and  the  political  nature    
of  accounting  measurement  
• Two  ques5ons  are  considered  when  making  choices  in  
rela5on  to  measurement  approaches  in  accoun5ng:  
1. What  do  users  really  need  to  know?  
• Measurement  will  affect  the  delivery  of  informa5on.  
2. How  do  users  influence  the  measurement  approach?  
• Recognise  the  impact  of  par5cular  users  or  stakeholders  on  
measurement  choices.  
• Dominant  stakeholders  will  always  have  greater  influence  on  the  
choices  made  and  approaches  taken  
Stakeholders  and  the  political  nature    
of  accounting  measurement  
• Exis1ng  and  poten1al  investors:  
• Concerned  with  the  risk  inherent  in,  and  the  return  provided  by,  their  
investments.    
• They  want  accoun5ng  informa5on  that:  
• assists  them  in  deciding  whether  to  buy,  hold,  or  sell  their  shares  
• enables  them  to  assess  the  en5ty’s  ability  to  pay  dividends.  
• In  order  to  provide  informa5on  about  poten5al  value  and  future  
viability,  en5ty  will  need  to  adopt  a  measurement  approach  with  a  
focus  on  current  values  
Stakeholders  and  the  political  nature    
of  accounting  measurement  
• Lenders  and  other  creditors:  
• Interested  in  informa5on  that  enables  them  to  determine  
whether  amounts  owing  to  them  will  be  paid  when  due.  
• Par5cularly  interested  in  the  en5ty’s  net  posi5on.  
• Liabili5es  compared  to  assets.  
• Measurement  becomes  very  important  from  a  valua5on  
perspec5ve.  
• Fair  value  seems  to  be  the  most  useful  approach.  
Stakeholders  and  the  political  nature    
of  accounting  measurement  
• Different  interest  groups  involved  in  accoun5ng  regula5on  
through  the  standard-­‐secng  process.  
• Each  group  lobby  for  a  par5cular  accoun5ng  treatment  or  
measurement.  
• Measurement  in  accoun5ng,  par5cularly  fair  value,  is  under  
the  spotlight.  
• Recent  poli5cal  measurement  issues:  
• reliability  of  accoun5ng  informa5on  prepared  using  fair  value  
• recent  events  blame  measurement  
 
Why  measurement  is  a    
controversial  accounting  issue  
• Measurement  is  currently  very  controversial.  
• Key  points:  
• Poten5al  for  inappropriate  choices  in  measurement  method  or  
approach.  
• Variability  in  measurement  approaches  used  for  similar  assets.  
• Poli5cal  influences  on  measurement  decisions.  
• Subjec5vity  and  discre5on  involved  in  determina5on  of  some  
values.  
• Impact  of  measurement  on  achievement  of  other  organisa5onal  
objec5ves.  
Current  measurement  
challenges  
• Green  assets  and  other  sustainability  issues:  
• Key  issues:  
• What  needs  to  be  measured  and  accounted  for  from  a  social  and  
environmental  perspec5ve?  
• What  are  the  consequences  associated  with  accoun5ng  for  social  
and  environmental  aspects  of  the  en5ty?  
Current  measurement  
challenges  
• Intangible  assets:  
• Ini5ally  measured  at  cost.    
• What  cons5tutes  cost  is  different  depending  upon:    
• whether  the  intangible  was  acquired  separately  
• acquired  as  part  of  a  business  combina5on  
• internally  generated.  
• Measurement  of  intangible  assets  is  complex  and  varia5on  exists.  
Summary  
• The  concept  of  measurement  in  the  current  context  of  financial  
repor5ng  and  benefits  and  limita5ons.  
• Standard  se[ers’  approach  to  measurement  and  different  
measurement  approaches.  
• Different  measurement  methods  and  the  impact  of  measurement  
choice  on  the  quality  of  accoun5ng  informa5on.  
• The  controversial  nature  of  fair  value  as  a  measurement  approach.  
• The  poli5cal  nature  of  accoun5ng  measurement.  
• The  issues  which  contribute  to  the  controversial  nature  of  
accoun5ng  measurement.  
• Current  measurement  challenges.  
Discussion  questions  
1. Discuss the development of measurement as highlighted by
Whittington(2015):
o Historical cost, current cost and fair value (Group 1)
2. Why is measurement so important in accounting? What is the
case for and against a single ideal measurement basis? Refer
to Whittington (2010)(Group 2)
3. What are the arguments for and against the use of fair value?
Did Fair Value contribute to the financial crisis in 2008?
(Group 3) Refer to Menicucci and Paolucci (2017)
4. Identify factors that may influence the choice of measurement
approach. Discuss how the choice of measurement approach
adopted affects the quality of accounting information
produced. (Group 4)

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