1. Chapter 4 Measurement PowerPoint Presentation by Matthew Tilling ©2012 John Wiley & Sons Australia Ltd

2. Measurement In Accounting Conceptual framework definition: 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. May involve calculation, estimation, and/or apportionment. Impacts quality and therefore usefulness

3. Benefits of Measurement 1.Makes financial statements decision useful – Gives meaning to the items included Allows users of accounting information to: 2.Assess an entity’s financial performance and position 3.Compare the entity’s performance and position over time. 4.Compare entities

4. Limitations of Measurement 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 results in the additivity problem.

5. Measurement Approaches And Accounting Standards The Conceptual Framework does not provide guidance as to which measurement bases should be used In reality a range of bases are used Historic cost remains dominant Steady shift towards fair value

6. Historical Cost Defined in the Conceptual Framework as: Assets are recorded at the amount of cash or cash equivalents paid or the fair value of 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.

7. Current Cost — Replacement Cost Defined in the Conceptual Framework as: Assets are carried at the amount of cash or cash equivalents that would have to be paid if the same or an equivalent asset was acquired currently. Liabilities are carried at the undiscounted amount of cash or cash equivalents that would be required to settle the obligation currently.

8. Fair Value — Realisable or Settlement Value Defined in the Conceptual Framework as: Assets are carried at the amount of cash or cash equivalents that could currently be obtained by selling the asset in an orderly disposal. Liabilities are carried at their settlement values; that is, the undiscounted amounts of cash or cash equivalents expected to be paid to satisfy the liabilities in the normal course of business.

9. Present Value Defined in the Conceptual Framework as: – Assets are carried at the present discounted value of the future net cash in flows that the item is expected to generate in the normal course of business. Liabilities are carried at the present discounted value of the future net cash out flows that are expected to be required to settle liabilities in the normal course of business.

10. Deprival Value Essentially the loss that would be suffered if an entity was deprived of the asset. Determination of the deprival value of an asset may incorporate: – present value if the item was held for use – net realisable value if the item was held for sale – replacement cost associated with replacing the item or the services that were received from the item.

11. Measurement and International Accounting Standards IASBs use a mixed measurement model different measurement bases are employed to different degrees and in varying combinations during the preparation of the financial statements. This leaves a large amount of flexibility and choice within particular standards

12. Measurement and International Accounting Standards

15. Future Directions on Measurement Measurement is an important part of the IASB Conceptual Framework Project Approaches tentatively considered: – Actual or estimated current prices – Actual past entry prices with adjustment – Prescribed computations or calculations based on discounted or undiscounted estimates of future cash flows

16. Decision criteria and influences on choice of measurement approach Significant influences include: – Potential users of the financial statements What will provide the most decision useful information – Practical considerations Is it possible to calculate Cost versus benefit – Managements motivations and objectives Short-term versus long-term Impact on incentives Reputational impact

17. Measurement And The Quality Of Accounting Information Measurement choices impact – Relevance – Faithful Representation – Understandability – Comparability – Verifiability

18. Historic Cost Relevance – Low: Especially as time passes Faithful Representation – High: Measures an objective transaction Understandability – High: Concept well known and understood Comparability – Medium: Purchasing power of money changes

19. Current Cost Relevance – High: Indicative of future potential Faithful Representation – High: Determined by reference to actual costs Understandability – Low: Can be subjective, depends Comparability – Medium: Can be subjective, depends

20. Present Value Relevance – High: Indicative of future potential Faithful Representation – Low: Can be very subjective Understandability – Medium: Assumptions used can be complex Comparability – Medium: Involves many different assumptions

21. Deprival Value Relevance – Low: Not related to business case Faithful Representation – Low: Can be very subjective Understandability – Low: Assumptions used can be complex Comparability – Low: Involves many different assumptions

22. Fair Value There appears to have been a distinct move from historical cost to fair value accounting. Valuation Methods – Market Approach – Cost Approach – Income Approach Current standard discussed in detail in Chapter 10

23. Arguments for Fair Value Relevance – Focuses on future potential Faithful Representation – Determined using objective market prices Understandability – Simply representation of current market value Comparability – Focus on market value not individual entity

24. Arguments Against Fair Value Relevance – Hypothetical and not relevant to specific entity Faithful Representation – If no objective market prices then highly subjective Understandability – Often based on complex assumptions and calculation Comparability – Different models lead to very different results

25. Stakeholders And The Political Nature Of Accounting Measurement Users have different and sometimes conflicting needs when it comes to accounting information. The impact and relevance of measurement to investors and other users of the financial statements is obvious. – What do users really need to know? – How do users influence the measurement approach?

26. 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. Therefore need forward looking information – Fair Value?

27. Creditors/Lenders 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 it has compared to its assets. Fair value would seem to be the most useful approach, assuming that items can be reliably measured.

28. The Political Nature of Accounting Measurement Different interest groups may favour different accounting measurement approaches. Fair value has been particular focus during the GFC. – May have made economic crisis worse – May not be reliable – May have hidden problems – May be difficult to regulate

29. Why Measurement Is A Controversial Accounting Issue Inappropriate choices of method. – Tension between flexibility and potential to mislead Variability in practice – Tradition has led to difference Subjectivity involved Impact of measurement on organisation – Short/long term impact on profit

30. Current Measurement Challenges Green assets and other sustainability 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?

31. Current Measurement Challenges Intangible Assets – Complexity and variation exists in terms of how intangible assets are measured on recognition

32. Current Measurement Challenges Water Assets – Water accounting standards are being developed in several countries, with no single body taking responsibility for international standards – Measurement and Valuation Wide range of stakeholders How should value be determined Water quality and recognition – Water is a limited natural resource which needs to be managed, measured and reported.

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