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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
2
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)
3
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=accounting7/30/2019 Lecture Topic 6 - Recognition and Measurement
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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
Godfrey et al Chapter 6 (168 - 171)
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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?
Godfrey et al Chapter 6 (171 - 174)
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
Godfrey et al Chapter 6 (174-179)
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
Godfrey et al Chapter 6 (179-183)
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Exit price accounting (EPA) What is it?
Godfrey et al Chapter 6 (183 - 185)
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
Godfrey et al Chapter 6 (185-188)
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Exit price accounting (EPA) Arguments against
Profit concept
Additivity
The valuation of liabilities
CCA vs. EPA
Godfrey et al Chapter 6 (188-190)
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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?