MEASUREMENT IN

ACCOUNTING

Introduction
Measurement in accounting refers to the
way the figures on the financial
statements are determined.
This process may include calculations,
estimates, comparisons, or allocations.
Measurement is an important issue for
both stewardship and decision-usefulness,
since poorly measured information would
lead to poor decision-making.

Benefits of measurement
1- It assists in making financial
statements decision useful by giving
meaning to the items included in
them.
2- It allows investors, management,
and other users of accounting
information to assess the financial
performance and financial position of
the entity.

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3- It allows investors, management,
and other users of accounting
information to compare the entitys
performance and position over time.
4- It allows investors, management,
and other users of accounting
information to compare entities.

Limitations of measurement
1- There is often little or no
agreement on what accounting
measures should be used.
2- The inherent flexibility and the
nature of a mixed measurement
approach reduces comparability of
accounting information.
3- Measurement can be subjective.

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4- The inherent flexibility is necessary to allow
entities to choose the method that will result in
the most true and accurate reflection of the
fundamental value of the item. This gives
management
the
opportunity
to
make
opportunistic accounting choices.
5- The current approach to measurement results
in an additivity problem. Can we realistically
add items in financial statements when they are
measured using different methods, and based
on measures from different dates?

Measurement approaches in
accounting
There are a number of different
measurement bases in accounting
which may be appropriate depending
upon the nature of the item and the
circumstances which exist at the
point in time when the item is
measured.
Among the most popular approaches
to measurement in accounting are:

 1- Historical cost
Until recently, historical cost
has been the most dominant
measurement basis in
the
preparation
of
financial
statements.

 Historical cost has been defined by IASB as

Assets are recorded as 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, at the amounts o cash or cash
equivalents expected to be paid to satisfy the
liability in the normal course of business.

 2- Current cost replacement

cost
Replacement costs are the costs
incurred to replace the item now.
Replacement cost requires an item to
be valued and recorded at the
amount that would be paid at the
current time to purchase an identical
item.

 IASB defines current cost as a

measurement basis according to
which 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

 3- Fair value realisable or settlement

value
This approach is recently gaining more popularity
due to its relevance.
IFRS 13 defines fair value 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.
Therefore, fair value is seen as an exit, rather
than entry, value.

 IASB defines realisable (settlement) value as

a measurement basis according to which
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.

 4- Present value
This is a subjective measurement basis that
takes into account cash flows that are
expected to be received in the future and
reduces them so that they can reflect their
value today. An accountant therefore has to
estimate the future cash flows and discount
them under an appropriate discount rate. This
basis values an item according to potential
benefits expected to be associated with it in
the future.

 IASB
defines
present
value
as
a
measurement basis according to which
assets are carried at the present discounted
value of the future net cash inflows 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 outflows that are expected to be
required to settle liabilities in the normal
course of business.

 5- Deprival value
This measurement basis is neither a
cost nor a value placed on an item,
but rather of already determined
costs and values to determine the
value of an item. It is essentially the
loss that would be suffered if an
entity was deprived of the asset. It
may incorporate more than one
measurement basis.

 See pages 96-97 (table 4-1) for a

detailed comparison of the five
approaches
to
accounting
measurement.

Measurement and international

accounting standards
International accounting standards employ
a number of different measurement bases
for the preparation of financial statements.
These bases include historical cost, current
cost, realisable value and present value.
While the standards prescribe what
measurement base to be used, there is still
some flexibility that is justified by the
different circumstances of each transaction.

 The problem of this mixed model is that it

provides opportunities for management
to manipulate financial statements rather
than aiming for showing reality.
It can be argued that a mixed model for
measurement in accounting is necessary
but subjective, and this leads to much
practice of professional judgement. This
calls for a role for ethics in this process.

 See figures 4-1 (p98), 4-2(p99), and

4-3 (p100) for examples of how the
mixed model is used for measuring
different items in accounting.

 The mixed approach is not favoured

in the convergence efforts between
IASB and FASB accounting standards.
The problem is that a single measure
is better justified if markets are
complete
and
in
perfectly
competitive equilibrium. In reality,
this is not the case.

 Factors that may influence the decision as to

which measurement base is most appropriate:
1- Who are the potential users of the financial
statements? and what are their needs?
2Practical
considerations
Can
the
measurement base be applied or is it difficult
to do so? Are the benefits of the use of the
approach higher than the costs of that?
3- Managements motivations or objectives
Are they short-term or long-term?

Measuring the quality of accounting

information
1- HISTORICAL COST
Historical cost is considered less relevant
because the amount paid in the past is not
reflective of the value of the benefits to be
derived from the item now and in the future.
However, it can be argued that historical cost
produces accounting information that is
more faithfully represented, as it is objective
in that it can be traced back to transaction
documentation.

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Historical cost information is also
generally understandable, given that
there are no complex formulas or
calculations involved in determining
it.
However, it is also considered less
comparable,
since
items
are
measured on different dates, and the
power of money changes over time.

 2- FAIR VALUE
Fair value is considered relevant because it
reflects what items are worth now rather
than what they were worth when they
were purchased.
Fair value is considered to be generally
subjective and less faithfully represented.
However, this is not necessarily the case
if an active market exists for the item.

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Fair value information is generally
considered understandable (simple
and straightforward) and comparable
(current and determined on the same
date).
Fair value information becomes less
comparable
if
the
value
was
determined
using
valuation
techniques,
rather
than
active
market quotes.

 3- CURRENT COST
Current cost information is considered
relevant since it is based on current
information.
It is considered faithfully represented if
the cost of the item is actual and
there is an active market for it.
Current cost is complex to calculate,
thus making it less understandable.

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As for comparability, current cost
information varies. It is generally
comparable given that data are
collected on the same date, but less
comparable given that different
entities have access to different
resources and are different in their
technological capabilities.

 4- PRESENT VALUE
Present value information is highly
relevant since it shows the present
value of future cash flows expected
to be derived from the item.
Present value information is low in
faithful representation and neutrality,
due
to
the
assumptions
and
judgement involved in the estimation
process involved.

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Present value information is low in its
understandability,
given
the
complex estimations and formulas
used.
It is comparable due to the information
being presented at the same date,
but the comparability is also limited
by the use of different assumptions
and estimations.

 5- DEPRIVAL VALUE
Deprival
value
lacks
relevance
because the entity is currently not
deprived
of
the
item
being
measured.
Deprival value also lacks faithful
representation, neutral depiction,
and understandability.

Fair value
Recently,
measurement
in
accounting is increasingly shifting
towards the use of fair value.
Fair value is to be determined by the
market value of the item. If not
available, market values of similar
items are used (after necessary
adjustments). Otherwise, fair values
are determined using a valuation
model.

Arguments for fair value

1- It is more relevant than items
determined using a cost-based method.
2- It can achieve faithful representation
when an active market for the item exists.
3- It can achieve neutral depiction when
an active market for the item exists.
4- It is comparable
5- It is understandable (compared to
several other measures).

Arguments against fair

value
1- It is subjective if there is no clear market
price in an active and liquid market.
2- Calculations and adjustments that can be
needed may be difficult to estimate and apply.
3- The problem of accounting for unrealised
holding gains and losses. Recognition of these
items may increase volatility of reported
earnings.
4- Limited faithful representation in the case of
using valuation models to determine fair value.