Hapter: Measurement Issues: Accounting For The Effects of Changing Prices and Changing Market Conditions

FINANCIAL ACCOUNTING THEORY
Craig Deegan
CHAPTER 5
Measurement issues: accounting
for the effects of changing prices
and changing market conditions
Slides written by Craig Deegan
Copyright © 2014 McGraw-Hill Education (Australia) Pty Ltd

PPTs to accompany Deegan, Financial Accounting Theory 4e 5-1
Learning objectives
5.1 Understand what ‘measurement’ means, why it is a potentially
controversial issue, and some of the factors that accounting
standard-setters might consider when prescribing a particular
measurement approach in favour of another.
5.2 Be aware of the various measurement approaches currently,
and potentially, in use.
5.3 Be aware of some particular limitations of historical cost
accounting in terms of its ability to cope with various issues
associated with changing prices and changing market
conditions.
5.4 Be aware of a number of alternative methods of asset
valuation that have been developed to address problems
associated with changing prices and market conditions,
including fair value accounting.

Learning objectives (continued)
5.5 Be able to identify some of the strengths and weaknesses

of the various alternative measurement approaches.
5.6 Understand that the calculation of income under a
particular method of accounting will depend on the
perspective of capital maintenance that has been adopted.
5.7 Be aware of the increasing use of fair value measurement
in accounting standards.
5.8 Be aware of evidence about the demand for, and
professional support of, alternative measurement
approaches.

Measurement
• What is it?
• According to paragraph 4.54 of the IASB Conceptual
Framework for Financial Reporting:
Measurement is 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. This
involves the selection of the particular basis of
measurement.
• Measurement is obviously a very fundamental issue in
financial accounting. Measurement allows us to attribute
numbers to the items that appear in financial reports

Process of mandating a particular
measurement approach could be
controversial
• When standard-setters require a particular
method of measurement in preference to others,
this can be controversial
• it can have profound effects upon financial

reports, and therefore also on agreements, or
contracts, that utilise numbers from the financial
statements

Alternative bases of
measurement
• There are various bases of measurement that
could be used, including:
– historical cost
– current costs
– realisable value
– present value
– deprival value

Choosing between alternative
measurement bases
• Determining how an asset or liability should be measured
should ideally be linked to the perceived objectives of
general purpose financial reporting
• According to paragraph OB2 of the IASB Conceptual
Framework for Financial Reporting, the objective of general
purpose financial reporting is:
to provide financial information about the reporting entity
that is useful to existing and potential investors, lenders and
other creditors in making decisions about providing
resources to the entity. Those decisions involve buying,
selling or holding equity and debt instruments, and providing
or settling loans and other forms of credit.
• The above perspective is often referred to as a ‘decision
usefulness’ perspective
Decision usefulness versus
stewardship functions
• ‘Decision usefulness’ and ‘stewardship’ are two terms
that are often used in relation to the role of financial
information
• The ‘decision usefulness’ criterion is considered to be

satisfied if particular information is useful (decision-useful)
for making particular decisions, such as decisions about the
allocation of scarce resources
• Decision usefulness appears to be the focus of financial

reporting currently embraced by the IASB and FASB
• An alternative focus other than ‘decision usefulness’ would

be ‘stewardship’

What attributes should financial
information have for it to be ‘decision
useful’?
• According to the IASB Conceptual Framework, to fulfill the
requirement that information is ‘decision useful’, financial
information should be both ‘relevant’ and
‘representationally faithful’ and allow financial statement
readers to make informed resource allocation decisions
• The IASB and FASB’s ultimate selection of a particular

measurement base will supposedly be tied to whether a
particular measurement approach enables the above
objective of general purpose financial reporting to be satisfied
• The IASB has identified three fundamental principles of

measurement that flow from the objective of financial
reporting

Three fundamental principles of measurement
• As IASB (paragraph 5, 2013b) states:
The following three fundamental principles of measurement are derived from the
objectives of financial reporting and the qualitative characteristics of useful
financial information as described in Chapters 1 and 3 of the Conceptual
Framework.
• Principle 1 The objective of measurement is to represent faithfully the

most relevant information about the economic resources of the reporting
entity, the claims against the entity, and how efficiently the entity’s
management and governing board have discharged their responsibilities
to use the entity’s resources
• Principle 2 Although measurement generally starts with an item in the
statement of financial position, the relevance of information provided by
a particular measurement method also depends on how it affects the
statement of comprehensive income and if applicable, the statements of
cash flows and of equity and the notes to the financial statements
• Principle 3 The cost of a particular measurement must be justified by
the benefits of that information to existing and potential investors,
lenders, and other creditors of reporting that information

The use of fair value – good for
assessing stewardship?
• Based on the increasing use of fair value in various newly-released
accounting standards it appears that the IASB considers that measuring
many classes of assets at fair value will provide more relevant and
representationally faithful information than measuring all assets at ‘cost’
• However, if by contrast, the primary objective of general purpose
financial reporting was considered to be ‘stewardship’, rather than
decision usefulness, then there is some argument that historical cost
provides a clearer perspective about what management has done with
the funds that were entrusted to it
• Demonstrating how funds have been used is a key component of
stewardship. However, there is also an argument that in assessing the
stewardship of management, interested parties would not only want to
know about the original amounts spent by managers, but also about
how monies spent have increased in value, and historical cost
accounting might be deficient in this respect

Variety of measurement bases
frequently used
• To this point we should understand that the
accounting standards issued by the IASB, and
therefore used within many countries globally, use
a variety of measurement bases
– for example, historical cost, fair value, present value
• This has been referred to as a mixed

measurement model of accounting
– creates issues associated with additivity

Factors to consider in selecting between
alternative measurement approaches
• The IASB and the FASB have identified a number of factors that
need consideration before a preferred approach (or a number of
approaches) to measurement is selected
• According to the website of the FASB, five factors that might be

considered in selecting among alternative measurement bases
(such as historical cost versus fair value) are:
– Value/flow weighting and separation The relative importance to
users of information about the current value of the asset or liability
versus information about the cash flows generated by the item, as
well as the ease and precision with which the flows can be
separated from the value changes (an indication of relevance)
– Confidence level The level of confidence that can be placed on

alternative measurements as representations of the asset or liability
being measured (an indication of faithful representation) continued

Factors to consider in selecting
measurement approaches (cont.)
– The measurement of similar items Items of a similar nature
should be measured in similar ways (an indication of
comparability)
– The measurement of items that generate cash flows

together Items that generate cash flows as a unit should be
measured the same way (an indication of understandability)
– Cost-benefit An assessment of the ratio of the benefits that

would be derived from alternative measurements to the costs
of preparing those measurements (an indication of the primary
limiting factor in financial reporting)
Obviously, as we can see from the above points, selecting the

appropriate measurement bases requires many judgments to
be made
One measurement option:
historical cost
• Under historical cost
– assets are recorded at the amount of cash or cash

equivalents paid, or the fair value of the 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

Limitations of historical cost in
times of rising prices
• Historical cost assumes money holds a constant
purchasing power
• Three aspects of the economy which make the

assumption less valid than when historical cost was
developed
– specific price level changes (shifts in consumer preference;

technological advances)
– general price level changes (inflation)
– fluctuation in exchange rates

Limitations of historical cost in times
of rising prices (cont.)
• Problem of relevance in times of rising prices
– asset’s current value may be different from historical cost
• Problem of additivity (adding together assets bought at

different times)
• Can overstate profits in times of rising prices, with

distribution of profits leading to an erosion of operating
capacity
• Including holding gains which accrued in previous

periods in current year’s income distorts the current
year’s operating results
Support for historical cost
accounting
• Predominant method used for many years so tended
to maintain support of profession
• If not found useful, business entities would have
abandoned it
• Nevertheless, recent accounting standards being
released have embraced ‘fair values’ as the basis of
measurement. However, various assets are still
measured on an historical cost basis
– e.g. inventory, which is measured at the lower of cost and
net realisable value; property, plant and equipment where
the ‘cost model’ and not the ‘fair-value model’ has been
adopted; many intangible assets

Definition of income
• How we measure assets will be influenced by how
we define income
• Income has been defined as the maximum amount
that can be consumed during the period, while still
expecting to be as well off at the end of the period as
at the beginning of the period (Hicks 1946)
• Consideration of ‘well-offness’ requires the
stipulation of a notion of capital maintenance
• Different notions of capital maintenance will provide
different perspectives of income
– different notions of ‘capital maintenance’ have implications
for how assets are measured
Capital maintenance perspectives
• Financial capital maintenance
– perspective taken in historical cost accounting
– profit earned only if money capital at the end of the period
is more than money capital at the beginning of the period
• Purchasing power maintenance
– historical cost accounts adjusted for changes in the
purchasing power of the dollar
• Physical operating capital maintenance
– profit earned if operating capacity at the end of the period
is greater than the operating capacity at the beginning of
the period

Development of accounting for
changing prices
• Perceived problems associated with historical cost
in times of changing prices lead to different
proposals for change away from historical cost
• Research initially related to using price indices to

restate historical costs to account for changing
prices
• Literature then moved towards current cost

accounting
– the basis of measurement changed to current values not

historical values

Current purchasing power
accounting (CPPA)
• One alternative to historical cost was CPPA
• Also called general purchasing power accounting;

general price level accounting; constant dollar
accounting
• Based on the view that in times of rising prices, if

an entity were to distribute unadjusted profits
based on historical costs, in real terms the entity
could be distributing part of its capital

Calculating indices
• A price index is used when applying general price
level accounting
• A price index is a weighted average of the current

prices of goods and services related to a weighted
average of prices in a prior period (base period)
– e.g. Australian Consumer Price Index (CPI)
• Can use a general or specific price index

Performing current purchase
power adjustments
• All adjustments are performed at the end of the
period
• Adjustments are applied to historical cost accounts
• Monetary and non-monetary assets considered

separately
– values of monetary assets do not change as a result of

inflation
– liabilities generally considered monetary items
continued

Performing current purchase power
adjustments (cont.)
• In times of inflation, holders of monetary assets will
lose in real terms
– the assets have less purchasing power at the end of the
period relative to the beginning of the period
• Holders of monetary liabilities gain, given the amount

they have to repay at the end of the period is worth
less than at the beginning

Performing current purchase power
adjustments (cont.)
• No change in purchasing power arises from holding

non-monetary assets
– non-monetary assets are restated to current purchasing
power so no gain or loss is recognised
• Purchasing power gains or losses are included in

income for the period

Movements in net monetary
assets
• Must identify changes in net monetary assets as a
result of revenues or expenses
• In times of rising prices there will be a loss in

purchasing power of cash received during the year
• More expenses are able to be paid earlier in the

year as more cash required for expenses incurred
later in the year

Example of CPPA Adjustments
(Deegan p. 182) Calculation of gain/loss of
purchasing power of net monetary assets
Unadjusted Index Adjusted
Opening net monetary (10,000) 140/130 (10,769)

assets
Sales 200,000 140/135 207,407
Purchase of goods (110,000) 140/135 (114,074)
Payment of interest (1,000) 140/135 (1,037)
Payment of admin (9,000) 140/135 (9,335)

expenses
Tax expense (26,000) 140/140 (26,000)
Dividends (15,000) 140/140 (15,000)
Closing net monetary 29,000 31,194

assets
The difference between the adjusted closing net monetary assets and the unadjusted net
monetary assets is treated as a loss - the company would have needed to have $2194 more
to have the same ‘purchasing power’ they had at the beginning of the year

Advantages of current
purchasing power adjustments
• Relies on data already available under historical
cost accounting
• No need to incur cost or effort to collect data about
current asset values
• CPI data also readily available

Disadvantages of current
purchasing power adjustments
• Movements in the prices of goods and services
included in a general price index (CPI) may not
reflect specific price movements in different
industries
• Information generated under CPPA may be
confusing to users
• Studies of share price reactions failed to find much
support for decision usefulness of CPPA data

Current cost accounting (CCA)
• Another alternative to historical cost that was
proposed was CCA
• CCA was based on actual valuations not adjusted

historical cost
• Differentiates between profits from trading and

holding gains
• Holding gains can be realised or unrealised
• Income perspective adopted will determine whether

holding gains or losses treated as income

Treatment of holding gains or losses
under alternative capital maintenance
approaches
• Financial capital maintenance perspective

– holding gains or losses can be treated as income
• Physical capital maintenance perspective

– holding gains or losses can be treated as capital
adjustments

CCA under physical capital
maintenance approach
• Advocated by Edwards and Bell
• Valuations based on replacement costs
• Operating income represents realised revenues

less the replacement cost of assets in question
• Generates a measure of income that represents

the maximum amount that can be distributed, while
maintaining operating capacity intact

Adjustments using Edwards
and Bell approach
• Adjustments usually made at year end
• Historical cost accounts used as basis of

adjustments
• Operating profit calculated by using replacement

costs
• Holding gains excluded in calculating current cost

operating profit
– not available for dividends

continued

Adjustments using Edwards and Bell
approach (cont.)
• BUT holding gains are included in calculating
business profit
• Business profit shows how the entity has gained in

financial terms from the increase in cost of its
resources
• Depreciation of non-current assets based on the

replacement cost
• As with CPPA no restatement of monetary assets

required

Advantages of current cost
accounting
• Differentiating operating profit from holding gains
and losses can enhance the usefulness of
information provided
– holding gains different to trading income as due to
market-wide movements that are often beyond
management’s control
• Better comparability of various entities’

performance

Criticisms of current cost
accounting
• Replacement cost of assets may not be the same
for all firms
– some firms may not choose to replace the asset
• If the entity requires replacement assets it may be

more efficient and less costly to acquire different
assets
• Replacement cost does not reflect what the asset

would be worth if sold
continued

Criticisms of current cost accounting
(cont.)
• Often difficult to determine replacement costs
• Allocating replacement cost via depreciation is still

arbitrary as with historical cost accounting
• Chambers (1995) claimed products of CCA were

irrelevant and misleading

Continuously Contemporary
Accounting (CoCoA)
• Yet another alternative to historical cost accounting
was CoCoA
• Proposed by Chambers as well as others
• Based on valuing assets at net selling prices (exit

prices) at reporting dates on the basis or orderly
sales
– referred to as current cash equivalent
• Chambers argued that key information for decision

making relates to ‘capacity to adapt’ continued

Continuously Contemporary
Accounting (CoCoA) (cont.)
• The balance sheet (statement of financial position)

considered to be the prime financial statement
– shows the net selling prices of the entity’s assets
• Profit directly relates to changes in adaptive capital
• Adaptive capital reflected by the total exit values of

assets

Capacity to adapt
• Chambers approach focuses on new opportunities
– the ability of the entity to adapt to changing circumstances
• The ability of the firm to ‘go into the market with cash
for the purposes of adapting oneself to contemporary
conditions’ (Chambers 1966, p.91)
• Assumes the objective of accounting is to guide

future actions (as opposed to, for example,
stewardship)

Definition of wealth under
CoCoA
• Present (selling) price is seen as the correct
valuation of wealth at a point in time
– past prices are a matter of history so not relevant to

current actions
• Profit is tied to the increase (or decrease) in the

current net selling prices of the entity’s assets
• No distinction between realised and unrealised

gains—all gains are treated as part of profit
continued

Definition of wealth under CoCoA
(cont.)
• Profit is the amount that can be distributed, while

maintaining the entity’s adaptive ability (adaptive
capital)
• Abandons notion of realisation in terms of

recognising revenue
– revenues are recognised at point of purchase or production
rather than sales

Capital maintenance
adjustment
• Unlike CCA there is an adjustment to take account
of changes in general purchasing power (inflation
adjustment)
• Capital maintenance adjustments form part of the

period’s income with a corresponding credit to a
capital maintenance reserve (part of owners’ equity)
• Calculated by multiplying net assets by the

proportional change in a general price index over
the period

Advantages of CoCoA
• By using one method of valuation for all assets
(exit values) the resulting numbers can be logically
added together (additivity)
• No need for arbitrary cost allocation for depreciation

as gains or losses on assets are based on
movements in exit price

Criticisms of CoCoA
• If implemented CoCoA would involve a fundamental
shift in financial accounting
– revenue recognition points and asset valuations
– could lead to unacceptable social and environmental
consequences
• Relevance of exit prices questioned if we do not

expect to sell the assets
continued

Criticisms of CoCoA (cont.)
• Assets of a specific nature considered to have no
value under CoCoA because cannot be separately
disposed of
– CoCoA ignores the ‘value in use’ of an asset
• Questioned whether appropriate to value all assets

at exit prices if the entity is a going concern
• Determining exit prices for unique assets introduces

subjectivity into accounts
continued

Criticisms of CoCoA (cont.)
• CoCoA requires assets to be valued separately
rather than as a bundle
– therefore would not recognise goodwill as an asset
– value of assets sold together can be very different from
separate sale

Fair value accounting
• Whilst CPPA, CCA and CoCoA as just described were
proposed as alternatives to historical cost accounting, another
approach that has been adopted is to simply measure
selected assets at fair value
• Fair value is an asset (and liability) measurement approach

that is now used within an increasing number of accounting
standards
• In the IASB’s accounting standard on fair value, IFRS 13 Fair

Value Measurement, fair value is defined as:
– the price that would be received to sell an asset or paid to

transfer a liability in an orderly transaction between
market participants at the measurement date

Fair value definition – key terms
• The definition of fair value uses a number of terms that
require further consideration, in particular ‘orderly
transaction’, and ‘market participants’
• These terms are defined in IFRS 13 as follows:
– orderly transaction A transaction that assumes exposure
to the market for a period before the measurement date to
allow for marketing activities that are usual and customary
for transactions involving such assets or liabilities; it is not a
forced transaction (e.g. a forced liquidation or distress sale)
– market participants Buyers and sellers are independent of
each other, are knowledgeable, having a reasonable
understanding about the asset or liability and the transaction
using all available information, and are willing and able to
enter into a transaction for the asset or liability

How do we determine fair
values?
• Fair values can be determined in different ways
• Techniques that rely upon observable market values
(market prices) are often referred to as mark-to-
market approaches
• Techniques that rely upon valuation models are often
known as mark-to-model approaches and require
the identification of both an accepted valuation
model, and the inputs required by the model to arrive
at a valuation

Fair value versus historical cost
• In comparing fair value to historical cost, fair value is
typically considered to be more relevant to the intended
users of general purpose financial reports
• However, it is a more subjective measurement basis if an
active market does not exist for an item
• If a valuation model is applied – because there is not an
active market – then many assumptions and professional
judgments must be made
• Determining fair value can be problematic when markets
are volatile, for example when there is a serious financial
crisis, or when an asset is of a type that is not regularly
traded. In such situation, management’s own judgments
and assumptions will impact measurement

A fair value hierarchy
• The IASB’s accounting standard on fair value
measurement establishes a ‘fair value hierarchy’ in
which the highest attainable level of inputs must be used
to establish the fair value of an asset or liability. As
paragraph 72 of IFRS 13 states:
– To increase consistency and comparability in fair value
measurements and related disclosures, this IFRS
establishes a fair value hierarchy that categorises into
three levels (see paragraphs 76–90) the inputs to valuation
techniques used to measure fair value. The fair value
hierarchy gives the highest priority to quoted prices
(unadjusted) in active markets for identical assets or
liabilities (Level 1 inputs) and the lowest priority to
unobservable inputs (Level 3 inputs).
continued

A fair value hierarchy (cont.)
• Levels 1 and 2 in the hierarchy can be referred to
as mark-to-market situations, with the highest level,
level 1, being (paragraph 76 of IFRS 13):
– Level 1 inputs are quoted prices (unadjusted) in active
markets for identical assets or liabilities that the entity can
access at the measurement date.
– Level 2 are directly observable inputs other than level 1
market prices (level 2 inputs could include market prices
for similar assets or liabilities, or market prices for identical
assets but that are observed in less active markets).
– Level 3 inputs are mark-to-model situations where
observable inputs are not available and risk-adjusted
valuation models need to be used instead.

Fair values and its relationship to
volatility and procyclicality in
accounting measures – a problem?
• A quantity or measure that tends to increase when
the overall economy is growing, or decreases when
the economy is declining, is classified as being
procyclical
• During the sub-prime banking crisis it was claimed

by many (especially banks themselves) that
accounting requirements – as reflected in various
accounting standards – that require reporting entities
to measure many of their assets at fair value actually
exacerbated the financial crisis
continued

Procyclicality attribute of fair values
(cont.)
• It is argued that when markets for financial assets
(such as shares, bonds and derivatives) are booming,
the value of these assets held by banks, and shown at
fair value within their statements of financial position,
will similarly rise significantly above their historical
cost – thus increasing the reported net assets and
capital and reserves of the bank
• As banking regulations usually set bank lending limits
in terms of a proportion (or multiple) of capital and
reserves, this increase in the reported fair value of the
assets of a bank will enable a bank to lend more
continued

(cont.)
• Some of this additional lending will fuel further
demand in the markets for financial assets – thus
further increasing the market values/prices of these
assets held by banks and further increasing their
reported capital and reserves
• This, it is argued, will enable banks to lend even
more and thus will help to create an upward spiral in
financial assets prices, and bank lending, that
becomes increasingly disconnected from the
underlying real economic values of the assets in
these markets
continued

(cont.)
• Conversely, it has been argued that at the time of the sub-prime banking
crisis when markets for financial assets were in free-fall, fair value
accounting exacerbated a downward spiral of asset prices and bank
lending that is equally unreflective of (and significantly overstates)
decreases in real underlying economic values
• Requirements to mark-to-market financial assets held by banks may
lead to a rapid erosion in the capital and reserves shown in the banks’
statements of financial position
• This will reduce their lending limits and will both reduce bank lending
(thus reducing demand in financial markets, putting further downward
pressure on the assets prices in these markets) and possibly require the
banks to sell some of the financial assets they hold to release liquidity
• This will put further downward pressure on the asset prices, leading to a
downward price spiral as these reduced prices further reduce the
reported net assets of the banks
continued

(cont.)
• Although these impacts of fair value accounting were widely articulated
at the time of the sub-prime banking crisis, Laux and Leuz (2009) argue
many of these claimed empirical effects were not caused by fair value
accounting, so the volatility and procyclicality case against fair value
accounting is not as clear cut as the above arguments indicate
• IFRS permit fair values to be determined using data other than direct
market observations in many circumstances – for example level 2 and
level 3 in the fair value measurement hierarchy
• In situations where markets are demonstrably not providing values

based on orderly transactions, or are for any other reason not operating
efficiently (for example due to illiquidity in the markets), then rather than
using level 1 fair value measurements (directly observed market prices
for identical assets), then level 2 mark-to-market or level 3 mark-to-
model valuations should be used
continued

(cont.)
• Laux and Leuz (2009) explain that during the sub-prime banking
crisis, many banks moved to using level 2 and 3 valuations rather
than level 1 valuations for many financial assets, and also took
advantage of provisions to allow some assets to be reclassified from
fair value to historical cost categories in special circumstances, thus
acting as a ‘damper’, reducing the speed (or acceleration) of any
procyclical effects
• They also argue that any failure to provide fair values in financial
statements during economic downturns could in itself cause markets
to overreact and/or misprice company shares
• Hence, there are arguments for and against the position that the use
of fair values contributed to the impacts of the global financial crisis
• Nevertheless, an interesting issue for accounting standard-setters to
consider – did fair values contribute to the global financial crisis and
therefore to various social and economic problems of the time?

Demand for price adjusted and value
adjusted accounting information
• Earlier we discussed various normative theories of
accounting (CPPA, CCA, CoCoA)
• Limited evidence that stock markets react to current
cost and CPPA information
– little or no share price reaction to price adjusted accounting
information found
– results may have been due to limitations with research
methods used
 reaction to other information released at the same time could
not be distinguished
 users may have obtained information from other sources prior
to release of annual reports
continued

Demand for price adjusted accounting
information (cont.)
• Surveys of managers find limited corporate support
for current cost accounting
– cost, limited benefits from disclosure and lack of

agreement as to approach are all considerations
• Surveys of users indicate information not helpful,

not used and information does not tell users
anything new
• Findings interesting given the extent of voluntary

disclosure by corporations

Reasons for lobbying
• Watts and Zimmerman examined lobbying reaction
to the release of FASB Discussion Memorandum
on general price level accounting
• Found that political visibility is a major factor in

explaining lobbying positions
– large firms favour general price level accounting as leads
to lower reported profits
continued

Reasons for lobbying (cont.)
• Supported in New Zealand by Wong (1988)
– corporations adopting CCA during period of rising prices
had higher effective tax rates and larger market
concentrations than those that did not
• In UK Sutton (1988) found politically sensitive firms

more likely to lobby in support of exposure draft
recommending disclosure of CCA

Professional support for
various approaches
• Current purchasing power accounting generally
supported by standard-setters from 1960s to mid-
1970s
• From about 1975 preference shifted to current cost
accounting
• Late 1970s and early 1980s standard-setters issued
recommendations which favoured a mixture of CPPA
and CCA
• From mid-1980s support waned (time of falling
inflation)

Potential reasons for lack of
continued support
• May question the relevance of current cost
information in times of falling inflation
• Drastic change to accounting conventions could

cause disruption and confusion in capital markets
• New method of accounting could have taxation

consequences
continued

Potential reasons for lack of continued
support (cont.)
• Self-interest motives of corporations
• Limited relevance to decision makers
• Nevertheless, in recent years there have been

movements towards the use of ‘fair values’ as
new accounting standards are being released


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FINANCIAL ACCOUNTING THEORY

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5.5 Be able to identify some of the strengths and weaknesses

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• it can have profound effects upon financial

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• The ‘decision usefulness’ criterion is considered to be

• Decision usefulness appears to be the focus of financial

• An alternative focus other than ‘decision usefulness’ would

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• The IASB and FASB’s ultimate selection of a particular

• The IASB has identified three fundamental principles of

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• Principle 1 The objective of measurement is to represent faithfully the

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Copyright © 2014 McGraw-Hill Education (Australia) Pty Ltd

– for example, historical cost, fair value, present value

• This has been referred to as a mixed

– creates issues associated with additivity

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• According to the website of the FASB, five factors that might be

– Confidence level The level of confidence that can be placed on

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– The measurement of items that generate cash flows

– Cost-benefit An assessment of the ratio of the benefits that

Obviously, as we can see from the above points, selecting the

– assets are recorded at the amount of cash or cash

– liabilities are recorded at the amount of proceeds received

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• Three aspects of the economy which make the

– specific price level changes (shifts in consumer preference;

– general price level changes (inflation)

– fluctuation in exchange rates

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– asset’s current value may be different from historical cost

• Problem of additivity (adding together assets bought at

• Can overstate profits in times of rising prices, with

• Including holding gains which accrued in previous

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Copyright © 2014 McGraw-Hill Education (Australia) Pty Ltd

• Research initially related to using price indices to

• Literature then moved towards current cost

– the basis of measurement changed to current values not

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• Also called general purchasing power accounting;

• Based on the view that in times of rising prices, if

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• A price index is a weighted average of the current

– e.g. Australian Consumer Price Index (CPI)

• Can use a general or specific price index

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• Adjustments are applied to historical cost accounts

• Monetary and non-monetary assets considered

– values of monetary assets do not change as a result of

– liabilities generally considered monetary items

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• Holders of monetary liabilities gain, given the amount

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• No change in purchasing power arises from holding

• Purchasing power gains or losses are included in