What is Measurement in Accounting?
The aim of this report is to discuss the different measurement bases in accounting. It will discuss the meaning, objective and importance of the measurement in accounting. It also delves deep into the characteristics that have to be necessarily judged for selecting the approach of measuring. A study of the framework provided by the International Accounting Standards Board (IASB) and the Australian Accounting Standards Board (AASB) will be conducted to find the different measurement bases prescribed for the items of a financial statement. Major measurement bases apart from the fair value accounting will be compared, and the fair value hierarchy will be explained. Lastly, a company that is listed on the Australian Stock Exchange will be selected to understand the various measurement bases used in its financial statements.
Measurement in accounting is an important and fundamental concept that determines the manner in which the financial transactions will be recorded in an organization. Every transaction in an organization is measured in terms of money in accounting but can also be measured using other units like the number of jobs, number of labor hours and many more. Measurement in accounting can be stated as the presentation of data according to a specified method. The data can be measured in various other methods, but consistency is an important concept in accounting for which firms have to follow the same method to allow comparability of financial data. While preparing the financial statements accountant has to choose between the various standards of measurement that are available as per the industry norms or regulations of the government (International Public Sector Accounting Standards Board, 2021). For example, an asset can be measured at the historical cost or the fair value of the asset as of that date. It is all about getting the correct value of a transaction to record in the books.
The objective behind the provision of the bases of measurement in the IASB is to find a balance between the reliability of information and faithful representation by allowing the presentation of data with estimates that are less uncertain (Accaglobal.com, 2022). The different bases of measurement are present in accounting to allow a company to present its financial information in the most suitable manner that depicts the correct image of its assets and liabilities. Most countries follow the standards laid out by the IASB for the measurement of their assets and liabilities, while some others follow the regulations provided by the government bodies. In Australia, the standards laid out by the AASB are followed by the companies registered in the country (Iasplus.com, 2022). The aim of such standards is to make the companies follow a pre-set standard for measuring their assets that are known to everyone. This enhances the comparability of the financials of the company year on year and among the industry peers.
According to the conceptual framework provided by IASB, the qualitative characteristics that are important for judging which measurement base to select are relevance and faithful representation (Accaglobal.com, 2022).
Relevance means relying on something to make a decision. In accounting, the users of the financial statements of a company have to rely on the information provided by the company. Financial information is relevant if it helps the user of the information in making decisions, which can come from the predictive and confirmatory value of the information (Dumitru, 2021). The predictive value of information allows the user to predict the future outcome and make decisions accordingly. At the same time, the confirmatory value of information lies in allowing the user to confirm the future predictions made by him previously. Thus, selecting a base for the valuation of assets and liabilities requires a judgment of the relevance of the information obtained.
QC 2: Faithful representation
Objective of Measurement in Accounting
The qualitative characteristic of faithful representation prescribes that the financial information of a company should be accurately presented in the financial statements. As per the conceptual framework, the financial statements can be faithfully represented only if it has three characteristics which are complete in all form, neutral in every aspect and free from any kind of error (Alkhresat & Almubaydeen, 2019). It requires all three attributes to be at the maximum level, if not possible to the full extent. So, the financial statements should present complete details about the financial performance and financial condition of the company. The second attribute, neutrality, requires the financial information to be free from any bias. The third aspect of free from any error does not mean that the financials have to be accurate in all aspects, but it requires that the estimates have to be used for arriving at the information and proper disclosure of the estimate is made.
The IASB conceptual framework provides two different bases of measurement, which are historical cost and the second is the current value. Then under the current value, there are three bases of that are fair value, the value in use and the current cost.
- Historical Cost- The historical cost of accounting states that the value of an asset is measured using the original cost of the asset (Budrionyt? & Gaižauskas, 2018). As per the conceptual framework provided in IASB, the non-financial items should be presented at the historical cost after adjusting for the usage of the item through depreciation and amortization. The financial items presented at the historical cost should represent the subsequent changes like the interest and payments.
- Fair Value- The fair value of an item is the current market value of an item of asset or liability. It is the value at which the item can be sold in the market (Toluwa & Power, 2019). It is used widely in the standards provided by IASB, where the fair value accounting is used to present most of the items of the financial statement.
- Value in Use- It is the net present value of all the future cash flows of an asset that can be generated through the use of the asset. It is calculated for each asset separately or the cash-generating unit as a whole (Icaew.com, 2019).
- Current Cost- The current cost of an asset or liability is the cost of acquiring the asset for the entity from the market. It is different from the fair value as it is the entry price of the asset or liability.
The major measurement bases except the fair value accounting are the historical cost, the current cost and the value in use. The historical cost is significant for accounting as the financial statements of a company are generated from the historical cost of the transaction for the period. It helps in ascertaining the actual cost of a company and comparing it with the revenue for the period. The historical cost of an asset is related to how the asset was brought into the business and shows the money spent on the asset. It comprises the purchase price of the asset along with the other cost involved in bringing the asset to use. The problem with historical cost is that it becomes irrelevant after a point in time as it does not consider the time value of money (Tkachuk, 2019). The historical cost of an asset is irrelevant as the present value of the asset would have changed from the original price. The approach also leads to other problems like the charging of depreciation on the asset being low due to the historic price of the asset. This inflates the profit of the business, which is different in actuality.
The second major bases of measurement are the current cost which considers the cost of acquiring the asset at present and values the items of the financial statement based on this value. This approach is also known as the net replacement value approach. This approach is based on the concept that a business is an ongoing entity that requires continuous replacement of its assets and liabilities. It is the most popular form of accounting for the effects of inflation. Under this approach, the assets are presented at their current cost of replacement, and the inventory is valued as per the date price on the date of consumption (Tamplin 2021). There are various problems associated with the current cost approach that beat the motive behind the use of this measurement base. The estimation of the current cost for each line item of the financial statement is time-consuming and increases the cost for the company. Sometimes the current cost of the item can be difficult to estimate, and the value has to rely on the guess and judgment of the accountant. This questions the reliability of the financial information that is presented in the financial statements of a company.
Measurement Standards Provided by IASB and AASB
Apart from the above two approaches, there is another base of measurement, the value in use, which uses the net present value of all the estimated cash flows from the asset and presents it as the value of the asset. This approach is mainly used in the estimation of the impairment cost of an asset as the assets should not be carried at an amount that is greater than the recoverable amount of the asset, less the cost of disposing of it, which is the value in use (Ifrs.org, 2022). The approach is based on the use of the asset by the entity, and it can differ for different entities making the financial information not comparable to others.
The IFRS 13 intends to improve the consistency of applying the measurement bases for items of financial statements by introducing the fair value hierarchy (Iasplus.com, 2022). The input that is required for the calculation of the fair value of an item is divided into three levels. These are the level 1, 2 and 3, which are divided as per the priority of their use in the calculation of the fair value of an asset or liability (Openriskmanual.org, 2022). This is known as the fair value hierarchy.
Level 1 is assigned to the price quoted in the active market for the assets that are identical to the asset or liability that is valued, and this is given the highest priority while considering the inputs for valuation. The price that is quoted in the market for the identical item is the most relevant evidence of the fair value of that item. The items are valued at the quoted price without any changes to them except in some cases (Accaglobal.com, 2022). An active market is a market where the item is traded in good volume and accessible by the entity. The other two levels are used only in case level 1 is not possible.
Level 2 is assigned to the price quoted in the active market or available from market data for the items that are not identical but similar to the ones being valued. At this level, some forms of adjustments are required to the price to bring it close to the price of the asset in question.
Level 3 of the hierarchy is the input that is unobserved and should be only used when the first two are not available. The input is not observable, so assumptions should be developed similar to a market participant while valuing the item. The use of this input should be avoided, and these should be used to the minimum possible (Filip et al., 2017).
According to the annual report of BHP Group Limited for the year 2021, the basis of the preparation section comprises the basis of measurement used in the financial statements of the company. The items in the statement have been measured at their historical cost except for a few items (BHP Group Limited, 2022). The overall financial statement of the company follows the historical cost base of accounting. The items that are not as per the historical cost approach are the financial assets like the derivatives that are valued as per the fair value accounting, and the non-current assets that are held for sale are valued at their carrying amount or the fair value less the cost of disposal, whichever is lower.
Qualitative Characteristics of Measurement
Major items and the measurement approach used for valuation of the item are as follows:
- Trade and other receivables: The trade receivables of the company have been recorded firstly at their transaction price, and after that the amortized cost is used by the effective interest method to value the item. In some cases that required financing components, those were valued using the fair value measurement. The receivables that were priced provisionally were valued using the fair value through the income statement method.
- Inventories: The inventories that are still in process and completed inventory are valued using the minimum of the cost or net realizable value. The inventories that are produced are valued as per the method of absorption costing. The average cost of inventory is used to determine the cost of each item of inventory.
- Property, plant and equipment: The property, plant and equipment of the company are valued at the net of cost and the accumulated depreciation and impairment loss. The cost is estimated using the fair value accounting method to get the fair value of the cost of acquiring the asset at the time it was acquired or constructed. The cost also includes the direct loss that is required in bringing the asset to the place and condition of use and the cost estimated to be in the future for the disposal and rehabilitation (Ifrs.org, 2022). The right of use assets or the leased assets is also valued in the same way.
- Goodwill: The goodwill is measured at the net of cost and impairment loss. Goodwill is recognized while acquiring a business, and the fair value of the assets, liabilities and contingent liabilities is less than the consideration paid for acquiring the business.
- Other intangible assets: The intangible assets except the goodwill are valued at the fair value of the consideration paid for the acquiring the asset less the accumulated amortization cost and the impairment cost of the asset.
- Impairment of non-current assets- The non-current assets are impaired as per IAS 36 when the indicators of impairment are present in an asset, and the carrying amount is more than the amount recoverable from it (Ifrs.org, 2022). The recoverable amount is maximum of the fair value, less the cost of disposal or the value in use of the asset or the cash-generating unit.
- Cash and short-term deposits: The cash and short-term deposits are valued at their carrying amount as they are considered to be at their fair value and do not carry any risk of change in value.
- Leases- Lease liabilities are valued at the current value of all the expected payments for the lease and adjustments are made for the interest expense, payments made, and any remeasurement due to modification in the lease.
- Financial assets- Every financial asset of the company is measured at the fair value of the amounts paid for purchasing. The fair value of the financial assets is measured using the inputs that are available for the different fair value hierarchy levels as per IFRS 13 (Ghio, Filip & Jeny, 2018).
Conclusion
As per the findings obtained in the above parts of the report, it is understood that there are various bases for the measurement of financial statement items in accounting. Every approach has its advantages and disadvantages, due to which the independence to use any has been provided in the conceptual framework of IASB. It puts importance on the aspects of relevance and faithful representation for which the financial statements should disclose all the information truly and with accuracy. BHP Group Limited has used various bases for the valuation of its line items in the financial statement as per the requirement of the applicable regulations. It is recommended that companies follow the same measurement bases consistently and discloses their method and estimates.
References
Accaglobal.com. (2022). IFRS 13, Fair Value Measurement | ACCA Global. Retrieved 17 April 2022, from https://www.accaglobal.com/lk/en/student/exam-support-resources/professional-exams-study-resources/strategic-business-reporting/technical-articles/ifrs-13.html
Accaglobal.com. (2022). Qualitative accounting characteristics | ACCA Global. Retrieved 17 April 2022, from https://www.accaglobal.com/an/en/student/exam-support-resources/foundation-level-study-resources/fa2/fa2-technical-articles/qualitative-acc.html
Accaglobal.com. (2022). The Conceptual Framework | ACCA Global. Retrieved 17 April 2022, from https://www.accaglobal.com/lk/en/student/exam-support-resources/professional-exams-study-resources/strategic-business-reporting/technical-articles/conceptual-framework.html
Alkhresat, A. S., & Almubaydeen, T. H. (2019). The Impact of the Application of International Standard for Financial Reporting No (9) on the Faithful Representation of Financial Accounting Information in Jordanian Commercial Banks. International Journal of Business and Management, 14(3), 88-97.
BHP Group Limited. (2022). BHP Annual Report 2021 [Ebook]. Retrieved from https://www.bhp.com/-/media/documents/investors/annual-reports/2021/210914_bhpannualreport2021.pdf?sc_lang=en&hash=15F0B58BC27ADFA860F0BE29B61E199D
Budrionyt?, R., & Gaižauskas, L. (2018). Historical cost vs fair value in forest accounting: the case of Lithuania. Entrepreneurship and sustainability issues, 6(1), 60-76.
Dumitru, A. P. (2021). The Relevance of Measuring Performance Using Financial Statements. Global Economic Observer, 9(1), 124-131.
Filip, A., Hammami, A., Huang, Z., Jeny, A., Magnan, M., & Moldovan, R. (2017). Literature review on the effect of implementation of IFRS 13 fair value measurement.
Ghio, A., Filip, A., & Jeny, A. (2018). Fair value disclosures and fair value hierarchy: Literature review on the implementation of IFRS 13 and SFAS 157. Paris France: Autorité des Normes Compatables.
Iasplus.com. (2022). Australia. Retrieved 17 April 2022, from https://www.iasplus.com/en/jurisdictions/oceania/australia#:~:text=The%20AASB%20is%20an%20agency,Financial%20Reporting%20Standards%20(IFRSs).
Iasplus.com. (2022). IFRS 13 — Fair Value Measurement. Retrieved 17 April 2022, from https://www.iasplus.com/en/standards/ifrs/ifrs13
Icaew.com. (2019). Applying IAS 36 impairment of assets [Ebook]. Retrieved from https://www.icaew.com/-/media/corporate/files/technical/financial-reporting/factsheets/ifrs/applying-ias-36-impairment-of-assets-factsheet-final1.ashx#:~:text=IAS%2036%20defines%20value%20in,rate%20to%20those%20cash%20flows.
Ifrs.org. (2022). IFRS – IAS 16 Property, Plant and Equipment. Retrieved 17 April 2022, from https://www.ifrs.org/issued-standards/list-of-standards/ias-16-property-plant-and-equipment/
Ifrs.org. (2022). IFRS – IAS 36 Impairment of Assets. Retrieved 17 April 2022, from https://www.ifrs.org/issued-standards/list-of-standards/ias-36-impairment-of-assets/#:~:text=The%20value%20in%20use%20of,individual%20asset%20cannot%20be%20determined.
Ifrs.org. (2022). IFRS – IAS 36 Impairment of Assets. Retrieved 17 April 2022, from https://www.ifrs.org/issued-standards/list-of-standards/ias-36-impairment-of-assets/#:~:text=About,asset%20is%20described%20as%20impaired.
International Public Sector Accounting Standards Board. (2021). Conceptual Framework Update: Chapter 7, Measurement of Assets and Liabilities in Financial Statements [Ebook]. Retrieved from https://www.ifac.org/system/files/publications/files/ED-76-Chapter-7.pdf
Openriskmanual.org. (2022). Fair Value Hierarchy – Open Risk Manual. Retrieved 17 April 2022, from https://www.openriskmanual.org/wiki/Fair_Value_Hierarchy#:~:text=Issues%20and%20Challenges-,Definition,Level%203)%20to%20unobservable%20inputs.
Tamplin, T. (2021). Current Cost Accounting | Inflation Accounting Definition & Explanation. Retrieved 17 April 2022, from https://learn.financestrategists.com/explanation/cost-accounting/inflation-accounting/current-cost-accounting-cca/
Tkachuk, N. V. (2019). Historical cost and fair value: advantages, disadvantages, application. Journal of History Culture and Art Research, 8(1), 173-182.
Toluwa, O., & Power, O. J. (2019). Fair Value Accounting: A Conceptual Approach. International journal of academic research in business and social sciences, 9(6), 683-696.
Order an Essay Now & Get These Features For Free:
Turnitin Report
Formatting
Title Page
Citation
Outline
