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The primary objective of the project is measurement basses for assets and liabilities. Certain present measurement standards and practices are incoherent to its standard. The present measurement provisions are limited and mostly out dated. In recognizing items in financial statements, each has its cost or value through reliability measurement. There aren't any significant differences between initial measurement and re-measurement as there are limit or prevent other alternatives when using initial measurement. Thus, potential suggestions for re-measurement must be re-assessed.
Chapter 2: Criteria for Evaluation
The objective of decision usefulness is to provide importance to predictive purposes and feedback value. Stewardship objective is to safeguard resources, ensure efficiency and profitability of the owner from undesirable economic consequences. Four of the important qualitative characteristics are relevance, reliability, comparability and understandability.
Relevance consists of predictive value and feedback value. Some standard setters consider timeliness as one of the dimensions. Predictive value is the capability to produce cash and cash equivalent at certain amount and time. Feedback value is using past activities as model to foresee the consequences of a future activity or else uncertainties will occur to the outcome. Reliability consists of representational faithfulness, neutrality and verifiability. Comparability allows users to differentiate the similarities and differences between two economic situations. Understandability means that users must have the right knowledge and willing to gain information.
The main focus of financial accounting and accounting measurement is the information on the amounts, timing and uncertainty of cash-equivalent flows that is the assets and liabilities of the business. Considering the cost or benefit constraint, practically entity pay the costs of providing financial information while the entity and external users obtained the benefits in making and confirming prediction. To entity, costs are more obvious and quantifiable than benefits. However, benefits are equally important as costs.
There are external changes and developments in the evaluation of measurement bases. Present value concept applied lead to vary in the accounting standard. Development in global capital markets, changes the features of derivatives and other instruments to be more complicated; and the financing and business arrangement to separate and distribute risks. These forces accounting standard setters to fit in or redevelop the traditional accounting recognition and measurement approaches which they are not good in. Research is also done to fair value measurements and statistical probability theory. Advances in computer and information technology leads to cost efficient and fasten the large data processes and difficult calculation. These developments contribute to the evaluation of alternative measurement bases from those basic conceptual frameworks. It also helps to overcome the weakness of the current conceptual framework objectives and supporting concepts.
Chapter 3: Possible Bases for measurement on Initial Recognition
There are two presumptions that is the relevant measurement date for assets and distinction of measurement on initial recognition from re-measurement. The possible bases of measurements are historical costs, net realizable value and deprival value.
Chapter 4: Market and Entity-Specific Measurement Objectives
Market value measurement objective are the market prices of assets and liability with uncertain future cash flows in a participative market. For understandability, it depends on market efficiency. The relevance depends on the accessibility of information to public at certain date. The predictive value requires the expectation rate of return along with volatility risks. The feedback value revises the market expectation. In comparability, it shows the market equilibrium price or another term the market expectation. The intention of acquirer does not affect the market value measurement.
Entity specific measurement objective are management assumptions and expectation without considering market prices. Entity might have critical information, trade secrets or changes that differ with market expectation. Management often knows more about the situation of the entity and responsible for business decision. For understandability, it based on management information on their expectations, assumptions and intentions; and how comparison is made. The relevance is restricted to management expectations. The predictive value is obtained through management expectations on measurement date. The feedback value revises management expectations. In comparability, it varies over time depending on management expectation.
Market value measurement produces better quality outcomes and more relevant than entity specific measurement in term of initial recognition. However, the entity specific information is more useful tools in providing supplementary disclosure information to public.
Chapter 5: Value Affecting Properties and Market Sources
Proposed that market value measurement objective only involve fair value of an item on measurement date. Either market or entity specific measurement objective are applied to predict the value affecting properties. The value affecting properties of contractual assets and liabilities reflect the expected cash flows related with risk. For non-contractual, it includes tangible and intangible characteristics and ownership rights.
There are two important kinds of unit of accounts of account issues in obtaining value affecting properties that are portfolio creation and the level of aggregation.
Portfolio is a group of investment that can remain their individual identities. For example, a portfolio loan can have different market value than the sum of the market values of individual item. The unit of account for measurement is the unit of account in which an entity acquires an asset or incurs a liability. Aggregation is the mix of individual item to form different assets or liabilities which lose their individual identities. The market value of aggregated asset may vary significantly with the sum of the market value of the individual items. The initial recognition of a non-contractual asset is at lowest level of aggregation where it is ready to generate future cash flows.
When measuring an asset or liability on initial recognition, entity should explore the market where the asset or liability occurs. Different price of same item in different market is the result of initial recognition, re-measurement by adding a fair value to that item.
Transaction costs are incremental cost to acquire or disposal assets beyond the fair value of the assets or liability. In market value measurement, the initial recognition excludes transaction costs while the entity specific measurement includes transaction cost For example, the import duty of particular product that paid by importer that cannot be recover in market place by reselling the product in domestic market is a transaction costs.
Chapter 6: Reliability
In reliability, it examines whether it is able to reasonably represent what it's mean to measure. It also defines as "faithful representation". There are two sources of measurement uncertainty that are estimation uncertainty and economic indeterminacy, which are also the limitation.
Estimation uncertainty estimates the judgment of the future outcome or uncertain current situation. To increase the reliability of uncertain measurement, good measurement policies, procedures and controls are needed. Economic indeterminacy in accounting consists of arbitrary allocations when the value of an item must be distributed to two or more assets or liabilities.
Information about measurement uncertainty on the character, size, and shape of the range of uncertainty is an important element in measuring the financial accounting. All the information is presumed by interested financial statement users. While evaluating the reliability of a measurement basis, consideration of the character and size of measurement uncertainty inherited; and the relevance and reliability of the supporting information on the character and size of measurement uncertainty.
Chapter 7 - Analysis of Alternative Measurement Bases
The main objective is to evaluate whether one or more combination bases which suits the initial recognition bests.
Fair value is one of the most relevant alternatives measurement bases which depends on entity-specific expectations because of its reliability and market value reflection. The reliability estimation of fair value must be truthful at market value. Then, compare with the other properties based on initial recognition. In certain circumstances the reliability of fair value is restricted when no obvious market price available for a property on a measurement date. However, it can be overcome with valuation models or techniques. The valuation model must subsequent with the purpose of estimating the fair value and assumptions that market participant will use when market-based information is accessible without excessive cost and effort. If there is no market-based information available, an entity may use its own assumptions but it is more of a substitution for fair value.
An observable market price is the most reliable source of fair value for the same assets or liabilities on the measurement date. It is suggested that an asset or liability's fair value on initial recognition should not be described by the price paid or received; unless convincing evidence is shown, except for certain assets and liabilities. The price of an asset or liability is assumed at its market price on the transaction date. However, an individual transaction prices might be different with fair value because of the ignorance, insufficient research or disadvantages bargaining positions.
Historical cost is used when the fair value of the asset or liability cannot be justified. It does not measure the value received and less relevant than fair value. The entity-specific measurement is used when the measurement basis differs from fair value. Traditionally, historical cost is the investment made to obtain benefits (revenues) from an asset. However, this cost-revenue matching objective is improved by measuring the assets at fair value compared with historical cost on initial recognition.
The limitations of using historical costs as a substitute to fair value on initial recognition are bargained exchange, allocation of costs, large indeterminacy, pre-recognition costs and cost recovery of an asset.
Current costs consist of reproduction cost and replacement costs. Reproduction cost replaces an asset with another identical asset. The cost is equivalent to historical cost on initial recognition except certain situation occurs. Reproduction cost measures the amount that is expended and not the value received. So, it must be supplemented by a recoverability condition. Replacement cost replaces an asset with another equivalent productivity capacity or service potential asset. This cost is a good performance measurement because it shows the organization capabilities in recovering its cost from revenue. It is also a good prediction measurement as it excludes the holding gains and losses. Fair value is a vital element in the replacement cost for the market expectation basis. Different value I obtained if the fair value is based on entity-specific expectations.
Current cost is more relevant than historical cost because historical cost measures what was paid or received while current cost measures the most economic and rational amount to be paid or received on initial recognition. The most relevant was the replacement cost, followed by reproduction cost and historical cost. Current cost should be used in preference to historical cost as a substitute for fair value when it is capable of reliable estimation and when it is reasonable to assume that it is recoverable for an asset or reasonably represents the amount owing if it is a liability.
Net realizable value measures the benefit value of an asset which focuses on sale. The asset fair value in the market represents the highest value and best use while net realizable value avoid the forces of insolvency sales price. Net realizable value is reduced by selling cost but not in the fair value case. In entity-specific expectations, net realizable value is different because the transaction cost is deducted. Net realizable value is used as a substitute of the fair value if the selling price is interpreted as a market value measurement objective, the cost is interpreted based on fair value meanings and exclusion of transaction costs.
Value in use is the present value of estimated future cash flows likely to arise from the continuance usage of an asset and disposal at the end of its useful life. In market expectations, value in use is similar to the fair value measurement. In entity-specific expectations, it measures the present value of the intended net cash inflows expected to be generated. Value in use is used as a substitute of the fair value if the present value technique is consistent with the fair value measurement. However, it is best used in pension plan and asset retirement without having to follow the fair value context.
The deprival value framework holds that the value of an asset to a business entity is the economic loss that the entity would suffer if deprived of it. The loss must be less than the most economic current cost. The replacement cost is the upper boundary as entity expects a return from excessive in the costs. Entity can recover the asset at a lower amount whether it sell its asset for its realizable value or use the asset and obtain its value in use if it faces loses in return. The entity will choose the alternative that gives the highest recoverable value. Deprival value is used as a substitute of the fair value if the management rational behavior overcomes the limitation of the replacement cost or the recoverable amount is higher than the value in use.
Chapter 8: A Synthesis and Some Consequential Recommendations
A measurement hierarchy on initial recognition is proposed in this paper. There are four levels where level 1 and level 2 is the estimates of fair value; level 3 and level 4 is the substitutes of fair value. In level 1, there is an obvious market price for similar assets or liabilities measured. In level 2, it weakens the obvious market price at level 1. Level 3 weakens the ability to estimate fair value with acceptable reliability. Level 4 is when the conditions in level 1, 2 or 3 are not met; an asset or liability should be measured on initial recognition on the basis of an accepted model or technique.
A number of issues such as secondary issues; nature and causes of different prices in different markets; defining the unit of account for measurement purposes on initial recognition; market pricing principles and techniques; the literature and practices of professional valuation disciplines have been raised for future research beyond the scope of this paper.