Chapter 4

Measurement

©2018 John Wiley & Sons Australia Ltd

 Learning objectives

After studying this presentation, you should be able to:

4.1 communicate the concept of measurement in the
current context of financial reporting and
demonstrate an understanding of its many benefits
and limitations
4.2 reflect on the standard setters’ approach to
measurement and evaluate different measurement
approaches
 Learning objectives

4.3critically apply different measurement methods to

evaluate the impact of measurement choice on the
quality of accounting information.
4.4communicate and justify the controversial nature of
fair value as a measurement approach consider the
arguments for and against a shift toward fair value
under the accounting standards
 Learning objectives

4.5reflect on the political nature of accounting

measurement by developing an understanding of the
different stakeholders in the financial reporting process
4.6communicate the issues which contribute to the
controversial nature of accounting measurement
 Learning objectives

4.7reflect on current measurement challenges faced by

the accounting profession with particular reference to
environmental sustainability, green assets, intangible
assets, heritage assets and water assets.
Presentation overview
 Measurement in accounting

• Measurement is the act or system of measuring.

• Paragraph 4.54 of the Conceptual Framework for
Financial Reporting (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 accounting context therefore
refers to the way the figures on the financial
statements are determined.
 Measurement in accounting

• Benefits of measurement:
1. It assists in making financial statements decision
useful.
2. Allows users to assess the financial performance
and financial position of the entity.
3. Allows users to compare the entity’s
performance and position over time.
4. Allows users to compare entities.
 Measurement in accounting

• Five key limitations of measurement in accounting:

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 to measurement results in
the additivity problem.
 Measurement approaches
and the accounting standards

• Measurement approaches:
– The Conceptual Framework does not provide
guidance as to which measurement bases should
be used.
– Feedback has been provided by the IASB regarding
the proposals associated with measurement.
– Historic cost is the most dominant measurement
base used by entities.
 Measurement approaches
and the accounting standards

• Historical cost:
– Dominant measurement approach.
– Traditional historical cost essentially requires
items to be recorded at the amount at which:
• they were purchased
• or they were received.
– Transactions are based on the past.
 Measurement approaches
and the accounting standards

• Current cost — replacement cost:

– Costs to incur replace items.
– Current cost:
• an item is valued and recorded at the amount
that would be paid at the current time to
provide or replace the future economic benefits
expected to be derived from the current item.
 Measurement approaches
and the accounting standards

• Current cost — replacement cost:

– Costs to incur replace items.
– Replacement cost:
• an item is valued and recorded at the amount
that would be paid at the current time to
purchase an identical item.
 Measurement approaches
and the accounting standards

• Fair value — realisable or settlement value:

– Becoming more popular due to the release of
AASB 13/IFRS 13 Fair Value Measurement.
– Considered more relevant from a decision
usefulness perspective.
 Measurement approaches
and the accounting standards

• Fair value — realisable or settlement value:

– Fair value:
• 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.
• Market‐based measurement.
 Measurement approaches
and the accounting standards

• Fair value — realisable or settlement value:

– Realisable value:
• An exit value representing the amount
expected to be received upon disposal of an
asset.
• Entity‐specific measurement.
 Measurement approaches
and the accounting standards

• Fair value — realisable or settlement value:

– Present value:
• Subjective 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

• Measurement and international accounting

standards:
– Utilises different measurement bases throughout
the preparation of financial statements and is
quite complex.
– Referred to as a mixed measurement model.
 Measurement approaches
and the accounting standards

• Measurement approaches: inventory:

 Measurement approaches
and the accounting standards

• Measurement approaches: property, plant and

equipment:
 Measurement approaches
and the accounting standards

• Measurement approaches: biological assets:

 Measurement approaches
and the accounting standards

• Decision criteria and influences on choice of

measurement approach:
– Prominent influences include on which
measurement base is most appropriate:
• potential users of the financial statements
• practical considerations
• management’s motivations and objectives.
 Measurement and the quality of
accounting information

• Measurement choices impact:

– relevance
– faithful representation
– understandability
– comparability
– verifiability.
 Measurement and the quality of
accounting information

• Historical cost:
– Less relevant, as it is not necessarily reflective of
the value of benefits (present and future).
– Produces information which is more faithfully
represented.
– More neutral as there is very little or no
estimation involved.
– Information produced is generally
understandable, but may less comparable.
 Measurement and the quality of
accounting information

• Fair value:
– Information produced using fair value as the
measurement base is argued to be more relevant.
– The quoted market price for an item is an
objective method for determining the fair value of
an item and is more faithfully represented.
– Information produced using fair value is viewed as
being more understandable and comparable
(arguably).
 Measurement and the quality of
accounting information

• Current cost:
– Information is more relevant than the use of
historical cost.
– Faithfully represented information due to the use
of actual current cost.
– Information is more difficult to interpret from a
decision usefulness perspective and therefore less
understandable.
– Values may be more comparable, but future
economic benefits may be less comparable.
 Measurement and the quality of
accounting information

• Present value:
– Values are more relevant.
– Due to the estimation involved, assumptions and
judgement the approach lacks faithful
representation and neutral depiction.
– Less understandable as approach involves
complex estimations and formulas.
– Comparable (arguably) as amounts are discounted
to the present day and in current dollars.
 Fair value

• Recently, there has been a distinct move from

historical-cost to fair-value accounting.
• Valuation methods:
– Market approach:
• Observable market prices and information
generated by market transactions.
– Cost approach:
• Reflects the current amount required to replace
the service capacity of an asset.
 Fair value

• Valuation methods:
– Income approach:
• Approximation of current market value is made
by estimating the future cash flows or income
and expenses.
 Fair value

• Arguments for fair value:

– More relevant as it reflects current market prices.
– Faithfully represents reality where other
measurement approaches cannot.
– Neutral depiction as fair values are primarily
determined using objective market prices.
– More comparable as the current value at the same
point in time is represented.
– Understandable as it is simple and straightforward.
 Fair value

• Arguments against fair value:

– Amount of subjectivity and judgement involved in
forming estimations of market value in the absence
of an objective market price.
– Value recorded is hypothetical in nature.
– Less faithfully represented due to the subjective
nature of the valuation process.
– The most controversial measurement approach.
 Stakeholders and the political nature
of accounting measurement

• Financial statements are used to satisfy different

needs for information.
• Users have different and sometimes conflicting needs
when it comes to accounting information.
• Measurement choices have an impact on the quality
of accounting information produced via the financial
statements.
 Stakeholders and the political nature
of accounting measurement

• Two questions are considered when making choices in

relation to measurement approaches in accounting:
1. What do users really need to know?
• Measurement will affect the delivery of
information.
2. How do users influence the measurement
approach?
• Recognise the impact of particular users or
stakeholders on measurement choices.
 Stakeholders and the political nature
of accounting measurement

• 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.
 Stakeholders and the political nature
of accounting measurement

• Lenders and other creditors:

– 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 compared to assets.
– Measurement becomes very important from a
valuation perspective.
• Fair value seems to be the most useful approach.
 Stakeholders and the political nature
of accounting measurement

• Lenders and other creditors:

– The political nature of accounting measurement
• Different interest groups involved in accounting
regulation through the standard‐setting
process.
• Each group lobby for a particular accounting
treatment or measurement.
• Measurement in accounting, particularly fair
value, is under the spotlight.
 Stakeholders and the political nature
of accounting measurement

• Lenders and other creditors:

– The political nature of accounting measurement
• Recent political measurement issues:
– use of fair value in times of economic
downturn
– reliability of accounting information
prepared using fair value
– recent events blame measurement
– stakeholders’ conflicting interests
– inadequate operation of financial markets.
 Why measurement is a
controversial accounting issue

• Measurement is currently very controversial.

• Key points:
– Potential for inappropriate choices in
measurement method or approach.
– Variability in measurement approaches used for
similar assets.
– Political influences on measurement decisions.
 Why measurement is a
controversial accounting issue

• Key points:
– Subjectivity and discretion involved in
determination of some values.
– Impact of measurement on achievement of other
organisational objectives.
 Current measurement challenges

• Green assets and other sustainability issues:

– Three key 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:
– Initially measured at cost.
– What constitutes cost is different depending upon:
• whether the intangible was acquired separately
• acquired as part of a business combination
• internally generated.
– Measurement of intangible assets is complex and
variation exists.
 Current measurement challenges

• Recognising and measuring the cost of intangible

assets:
 Current measurement challenges

• Heritage assets:
– Considered to be a subset of property, plant and
equipment.
– No single definition but definitions follow the same
idea:
• these assets are of some sort of historical,
artistic, cultural or environmental significance
• are held and maintained for their contribution to
knowledge and for the benefit of present and
future generations.
 Current measurement challenges

• Heritage assets:
– Issues:
• Should heritage assets be treated in the same
way as other tangible assets? Or should they be
treated as a liability?
• Are heritage assets capable of financial
measurement?
• Should heritage assets be financially measured?
 Current measurement challenges

• Water assets:
– Developing reporting and assurance standards for
water resides with the national Water Accounting
Standards Board (WASB).
– Measurement and valuation:
• Number of issues associated with the
measurement or valuation of water as an asset.
 Current measurement challenges

• Water assets:
– Measurement and valuation:
• Wide range of stakeholders:
– All have diverse interests.
– Economic, environmental and social factors
need to be considered.
• How should value be determined:
– Issues surrounding determination of value.
 Current measurement challenges

• Water assets:
– Measurement and valuation:
• Water quality and recognition:
– Water is a limited natural resource which
needs to be managed.
– It must be given value and accounted for in
the same way as any other asset.
 Summary

• The concept of measurement in the current context

of financial reporting and benefits and limitations.
• Standard setters’ approach to measurement and
different measurement approaches.
• Different measurement methods and the impact of
measurement choice on the quality of accounting
information.
• The controversial nature of fair value as a
measurement approach.
 Summary

• The political nature of accounting measurement.

• The issues which contribute to the controversial
nature of accounting measurement.
• Current measurement challenges.