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Measurement in accounting has been a subject of attention in recent time. Users of financial statement need reliable, relevant and accurate information to make decisions. Unlike scientific measurement, accounting measurement deal with monetary value; it is based upon accounting standard and prescriptive theories. With the identification of different accounting measurement methods and its effect in financial reporting information, it has created more complexity in the comparability, uniformity and overall reliability of the information. This report will be focused on recent controversies in accounting measurement including the analogy of historical & fair value accounting method and issue regarding conceptual framework.
Interpretation and Analysis
As stated in ICAEW (2011) the main issue regarding accounting measurement issue has been pointed out as follows:
- There are many basses for measurement. One basis cannot be appropriate to measure all economic activity. One basis in one scenario can be useful while in other cases it might not. Hence the measurement is based upon the purpose of financial reporting information. It leads to different figures in different bases, which is one of the issues.
- As accounting has double entry system, an effect in one thing make equal in other thing as well. Only a single item can not valued which creates difficulties in the measurement.
- Accounting measurement can only display snapshot of the financial transaction; it cannot incorporate the incomplete transaction or transaction which are in process. This difficulty is caused because difficulty in defining separable asset to be measured, identifying market for them, allocating values to them in terms of past and future accounting periods and subjective judgment about incomplete transactions.
- Many accounting measurement are based upon expectation or prediction such as value of asset are determined by predicting how much cash flow it will generate in future. Similarly the depreciation expenses are determined predicting the useful life of the assets. Different provision in accounting is based upon the likability of future payments. The prediction is just a calculation of mind, which cannot result into expected outcome.
- In instances where cost and revenues has to be allocated throughout the different period, the subjective analysis makes impact upon the measurement in the result of financial reporting.
- In the CCA method, it is very difficult to measure economic activity in the absence of perfect or active market. The analysis in this case will be based upon subjectivity.
Accounting measurement has become a controversial issue in the recent time because of some measurement issues pointed out above. The gradual shift of accounting measurement to fair value has caused roar in business world. With this change, it will have a big impact in financial reporting information that determines the overall faith of the business and the perception of stakeholders as well. Hence it has been a subject of debate.
Historical cost accounting method has been used from a long time. However, over the periods historical costing is being criticized for its objectivity, relevance and reliability. As per the recent changes in accounting standard, it has been revealed that the accounting measurement in fair value has gained more popularity than historical method. This shift in accounting treatment is due to multiple reasons.
Historical Cost (HS) accounting recognizes the value of asset and liability as they happened or in other word they recognize the value of asset in their original purchase price and liability at the price when transaction happen. The problem with HS is, it neither take price level change or take time value into consideration. It doesn’t record unrealized gain or loss in times of price level changes. Due to this, this accounting treatment fails to show the real financial position. For example under the HS, the value of land will still be the same today, it purchased five years back. This scenario undervalues the financial strength of the company in financial reporting. However in case of price level change exactly opposite effect happens. Deegan (2014) also says that HC method overstate profit in times of rising prices and dividend payment in such time indeed operating capacity erosion. As HC fail to consider price level changes, financial statement produced under this basis cannot assure investor to rely upon this report to make judgments. It can be considered relevant while other methods such as fair value are in place, which succeed to deal with such problems. Therefore I think accounting measurement practice is moving toward fair value from historical value.
Despite the popularity of fair value to historical value the conceptual framework has not prescribed any alternative to HC accounting. Practically it will be very difficult to conceptualize the framework on the favor of method like fair value method. In the absence of active market, it is very difficult to derive the absolute value of economic activity. Methods based on fair values are very complex and adds confusion in the understanding. Its application, not only add complexity but also will be very costly to manage. In 2008 GFC many company failed to sustain because they overvalued their company taking advantage of fair value method. On the other hand HC accounting is still very simple, realistic accounting measurement method, and still considered to be best for stewardship role. Stakeholders actually can evaluate that what managers originally have done with the investor’s fund. Besides, as it doesn’t consider the unrealized gain, it is perceived as conservative, hence is desirable for investors and taxpayer point of view. Apart from strength of HC, addition of other methods in CF might further add more controversies. Because of these reasons it has been thought that the conceptual has not been amended to stipulate an alternative of historical cost.
To the alternative of HC, other measurement method like, CPPA, CCA, realizable value, value in use, can be incorporated. All these measurement methods are explained backed by their own logics. These methods do not fit into all business structures, hence it is very important to understand the essence of these choices. The application of wrong choices could lead into unreliable financial report. If stakeholders are to rely upon this report for making decision, they will end up into wrong decision and could have negative impact upon the image of the company itself.
There are different users of financial reporting information. Different users have different perception and motive towards financial reporting. This thinking leads to demand of different approaches in accounting measurement. Historical Costing and Fair Value costing methods are in the current interest for stakeholders. It is very difficult to conclude which method is the best because both methods hold some strong and weak points. Not all businesses are same in structure. Their differences in nature and operation have caused to incorporate different accounting measurement. A single CF cannot incorporate the interest of all businesses hence to determine right and wrong approach is still a big question.
Conceptual Framework (CF) is designed in such a way, which facilitates to communicate ideas, principle and concept in understandable way. CF in any discipline plays very pivotal role in forming concrete ideas to drive social world. It simply provides guidelines to why and how certain activities should be done. In addition to this, it gives confidence to the people to forming an idea and to believe in ideas to make decisions. This report further will be focus on the statement of Hines regarding CF and recent developments of CF referring to the discussion paper on “Review of the Conceptual Framework for Financial Reporting” IASB. (2013).
Analysis and Interpretation
As per Deegan (2014, p. 214), FASB has defined CF as a “coherent system of interrelated objectives and fundamentals that is expected to lead to consistent standard and that prescribes the nature, function and limits of financial accounting and financial statement.” CF provides guidelines to professional body, a right approach of doing things. CFs is derived from value judgment from the researchers and give direction to professional people to set standards. It suggests the things like how and when to recognize income & expenses and asset & liabilities. In addition to this CF also advises corporate body different principles of corporate governance, and explain how it will be useful for them and to society. Professional body like AASB, IASB etc closely follow the CFs and introduce standards as required. CFs satisfies all features close the normative theory like: based on value judgment, prescriptive, derived from deducting approach etc. hence in large extent it can be considered as normative theory.
Despite the fact that it is widely accepted the pivotal role of CF in shaping social world, some researchers have criticized it. In one statement in Hines (1991), he opines that CFs are merely designed for social legitimacy. He considers objective assumption as central premise to develop CFs in social world. The concept of reliability and relevancy together form the concept of objectivity. Objectivity assumption endorses the independent and unbiased reporting to society. Objectivity supports the principles backed by strong evidences not just personal opinions. Legitimacy can only be gained through maintaining objective assumption, as this assumption ensures quality of information like representationally faithfulness and reliability. Social legitimacy means to establish the profession as socially accepted. Accounting profession is relied upon the CFs. Accounting standard are set in accordance with guidelines in CFs. This gives reason to society to reckon accounting profession as legal body or it gives social acceptance to accountants’ work and legitimizes its action in the society. The objective of CFs indeed is not to benefit the financial reporting user but to protect the interest of those standard setters. Hence the existence of the CF adds no value to society. He denies the core objective of CF as only to ensure to improvement in the practices of doing things. CF rather is more focused on to benefit the profession. Along with this, as stated in Deegan, (2014. p. 257) “Hines (1989) provides evidence that conceptual framework projects were actually initiated at times when profession were under threat- that they are a strategic manoeuvre for providing legitimacy to standard setting boards during periods of competition or threatened government intervention”. This statement reflects a harsh criticism on CFs by Hines.
IASB established in 2001 is independent accounting professional body that is responsible for developing International Financial Reporting Standard (Wikipedia, 2014). IASB monitors and timely issues new development in IFRS as required. In 2010 IASB along with FASB introduced changes in two chapters: The objective of general purpose financial reporting and qualitative characteristic of useful financial information, in conceptual framework. Following this, they also further put light on the concept of reporting entity by publishing Discussion Paper and Exposure Draft. And further discussed about element of financial statement & measurement issues in accounting. In year 2012 after going through public consultation IASB came to understand the priority of Conceptual Framework project, hence, it has started to rework on developing new conceptual framework which is now expected to finish by 2015. In the new framework, IASB shall be more focused on element of financial statements, recognition and derecognition, measurement, presentation and disclosure and the reporting entity. The new CF shall also assist other parties includes IASB.
The timely development of conceptual framework is very important in order to address ongoing issues in accounting measurement. CFs have some criticism but its importance in the professional autonomy is undeniable. CFs provides thorough guidelines to set new standard or to bring changes in the current standard. These standards are to mitigate the issues in accounting measurement and boost the public confidence in the system.
Deegan, C. M. (2014). Financial accounting theory (4th ed.). NSW, Australia: Mcgraw Hill.
Godfrey, J., Hodgson, A., Tarca, A., Hamilton, J., & Holmes, S. (2010). Measurement theory. In Accounting theory (7th ed). (pp. 133-160). Milton, Qld. : John Wiley.
Wikipedia, 2014 nd, International Accounting Standard Board. Retrieved from http://en.wikipedia.org/wiki/International_Accounting_Standards_Board
ICAEW (2011). Measurement in Financial Reporting, Information for Better Market Initiative: Financial Reporting Faculty.
In Accounting theory (7th ed.)(pp. 133-160). Milton, Qld. : John Wiley.