Lecture Topic 6 - Recognition and Measurement

7/30/2019 Lecture Topic 6 - Recognition and Measurement

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TOPIC 6 (part A)

RECOGNITION & MEASUREMENT

ATPB 313

ACCOUNTING THEORY AND PRACTICE

SEM I 2013/2014

(updated July 2013)


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Learning Outcome

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At the end of this lecture, students should beable to :

1Examine the concept of measurement in accounting

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Explain different types of measurement systems in accounting i.e. historical cost and its alternativemeasurement i.e. current cost (entry value) , current selling price (exit value), and fair value

3Discuss the advantages and disadvantages of each measurement system

5Be aware of current development in accounting measurement


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.the assignment of numerals to represent properties of materialsystems other than numbers, in virtue of the laws governing theseproperties.

(Campbell, 1938)

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What is measurement?

.the assignment of numerals to objects or events according to

rules.

(Stevens, 1946)


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Types of measurement

Numbers assigned by reference to natural lawsFundamentalmeasurement

Depends on the measurement of two or more otherquantities

Derivedmeasurement

Based on arbitrary definitions

May lead to poor confidenceFiatmeasurement

Godfrey et al Chapter 5 (138 140) & 145


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Measurement in accounting

Key questions: What value forassets, liabilities, revenues andexpenses provides relevant andreliable accounting information tofinancial statement users?

Development of accountingsystems based:

- Historical cost accounting- Current cost accounting

- Exit price accounting

- Present value

- Latest: Fair value accounting


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Historical cost accounting (HCA) What is it?

The traditional method of accounting, in which accountants recordrevenue, expenditure, and asset acquisition and disposal at historicalcost i.e. the actual amounts of money or money worth, received orpaid to complete the transactions

However, it is usually modified in its application by the revaluation offixed assets such as land and buildings.
http://www.anz.com/edna/dictionary.asp?action=content&content=accountinghttp://www.anz.com/edna/dictionary.asp?action=content&content=revaluationhttp://www.anz.com/edna/dictionary.asp?action=content&content=revaluationhttp://www.anz.com/edna/dictionary.asp?action=content&content=accounting


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Historical cost accounting (HCA) Basic concepts

Objective ofaccounting:

Stewardship oraccountability

Capital and profit

Matching of coststheory

Conservatism

Godfrey et al Chapter 6 (162 165)


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Historical cost accounting (HCA) Arguments for

Relevant in making economic decisions

Based on actual, not merely possible, transactions

Data have been found to be useful

The best understood concept of profit

Must guard data against internal modifications

Profit based on alternatives may not be useful

Market prices can be supplementary data

Insufficient evidence to reject it

Godfrey et al Chapter 6 (166 - 168)


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Historical cost accounting (HCA) Arguments against

Objectives of accounting

Information for decision making

Basis of HCA

Matching

Notion of investor needs



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So, what are the alternative models of

accounting measurement?

Major normative proposals:

o Base accounting on current (replacement) costs

o Base accounting on net selling price (exitprice)of assets

oAdjust HC by an index of changes in the general

price level


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Current cost accounting (CCA) What is it?


Definition: Assets are valued at their current market buyingprice and profit is determined using matching expenseallocations based on the current cost to buy

Underlying rationale:

CCA information is more decision-useful

Edward & Bell (1961) concepts of business profit is currentoperation profit plus realizable cost saving / holding gainsor losses resulted from holding the asset

Holding gains represent a saving attributable to the fact thatthe input was acquired in advance of use and determinewhether holding activities are successful


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Financial capital versus physical capital: An illustration

Current cost accounting (CCA) 2 views on CCA

Godfrey et al Chapter 6 (174-179)

Consider a company begins operations with RM1000 cash on 1 January andimmediately purchases 100 units for RM10 each. On 31 January, it sells all theunits for RM 18 each. On this date, the current cost has risen to RM12 a unit.Assume that profit is paid out as dividends at the end. The calculation of profitis as follows:


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Current cost accounting (CCA) 2 views on CCA


Profit is RM800 because this is theincrease after FC is maintained. IfRM800 is distributed to the owners

as dividends, the company still hasRM1000, which is the amount of the

beginning capital

Financialcapital view

The firm has 100 units at the beginning and itmust in a position to purchase 100 units at theend of the period

Because the price has risen RM2, the firm needs

RM200 more at the end of the period tomaintain its beginning operating capability

Therefore, the RM200 is not a holding gain, buta capital maintenance adjustment

Physicalcapital view


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Current cost accounting (CCA) Arguments for/against

Recognition principle

Objectivity of CCA

Technological change

CCA vs. HCA and exit price



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Exit price accounting (EPA) What is it?


Definition: A system of accounting which uses market sellingprices to measure firms financial position and performance

Underlying rationale:

The adaptive nature of a company involves actions in marketand hence the need for regular information about what it mayobtain by selling its assets

The company, therefore, needs to know the cash and cashequivalents of its net assets i.e. based on current market selling

price


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Exit price accounting (EPA) Arguments for

Providing useful information

Provides relevant and reliable information

Additivity

Allocation

Reality

Objectivity

A measure of risk



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Exit price accounting (EPA) Arguments against

Profit concept

Additivity

The valuation of liabilities

CCA vs. EPA



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Fair value accounting (FVA) What is it?

Definition: 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 (MFRS 13).

It is a market-based measurement and not entity specific measurement.

IASB/FASB have agreed that FV is the best measurement basis (2004). InMay 2011, both IASB and FASB issued guidance on FV measurementand disclosure requirement that makes both standards largelyidentical(for details guidance please refer to MFRS 13).

CCA and EPA can be said as represent market/fair value accounting


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Fair value accounting (FVA) Arguments for

Reflects current market condition

Transparency

More accurate, updated, timely, and comparable

Gains/losses indicates economic events worthy as additional disclosure

Limit companies ability to manipulate the income

A warning system to stay away from highly volatile assets


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Fair value accounting (FVA) Arguments against

Reliability in illiquid market

Subjective

Uncertainty

Reported losses can be misleading and increase the risk ofoverall financial system


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Present value

o Closest to true economic concept of value

o Involves:

future cash flows

behavioral assumption

discount rate

o Subjective value (moving away from objectivity)


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Understanding IFRS measurements: The cross-cutting issues

o Example of issues to consider:

Single measurement or mixed measurement model for all assetsand liabilities

How to consider and apply relevance and faithful representation

to the selected measurements?

If items are remeasured, how to display the effect of changes of

measurement in the statement of comprehensive income?

o What is the latest update of IASBs discussion?


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Summary of Topic 6 (part A)

Measurement

Fundamental Derived Fiat

Accounting

How tomeasure A,

L, E, & R

HCA The actual

amountreceived/paid tocomplete thetransactionAdvantages?Disadvantages?

CCA Current market

buying price Advantages?Disadvantages?

EPACurrent market

selling priceAdvantages?Disadvantages?

FVARefer to MFRS 13

Advantages?Disadvantages?

Currentinterest of

IASB &MASB

Present ValueDiscounted cash

flowAdvantages?Disadvantages?

Lecture Topic 6 - Recognition and Measurement

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