Measurement in accounting is probably the most controversial issue at present time, with a trend towards fair value usage. The accounting standards have adopted what is called a mixed measurement model and in this paper we make a closer examination of accounting measurement and accounting measurement systems and taking a look at the Adelaide Brighton Limited’s balance sheet and their measurement approach.
Measurement is defined by Campbell as assigning numerals to properties of material systems like a house, a table, even people, or distances travelled. This assignment of numerals to the properties of these systems is done according to the natural laws governing those principles. Another theoretician in the field of measurement is Stevens. As Godfrey et al. (2010, p.134) presents, Stevens believes that the numerals should be assign according to the rules. This raises the need for all sorts of restraints to use in making the rules; otherwise numerals can be assigned to anything.
Accounting measurement is defined by the Conceptual Framework as: “The process of determining the monetary amounts at which the elements of the financial statements are to be recognized and carried in the balance sheet and income statement”.
Measurement in an accounting context therefore refers to the way the figures on the financial statements are determined. It is described as an act or process which may involve calculations (for example calculations to determine the inventory), making estimates and comparisons(for example determination of fair value of an asset by comparing with the market value), and apportioning or distributing amounts, like amortization or depreciation of an item.
According to Goyen (2012, Topic Notes) estimates cannot meet the scientific definition of measurement because it cannot be determined by the natural lows governing those specific properties. Furthermore, Rankin et al. (2012, p.91) gives the example of present value as an accounting measure. However, the calculations representing present value for a specific item are more estimates than measurements.
There are three main types of measurement. Fundamental measurement is one where the numbers can be assigned to properties based on natural laws (confirmed empirical theories), and “which does not depend on the measurement of any other variable”. (Godfrey et al., 2010, p.138) Examples are length, electrical resistance, number and volume.
According to Campbell, a derived measurement is one that depends on the measurement of two or more quantities. However, perhaps it is better to say that it depends on at least one other quantity and is still based on natural law. An example is density, which is based on the measurements of mass and volume. (Godfrey et al., 2010, p.138)
An example in accounting is income, which uses asset values as a basis to estimate cost (depreciation, bad debts, etc.). Godfrey suggests that profit is an example of derived measurement because “it is derived from the addition and subtraction of income and expenses.” (Godfrey et all., 2010, p.139)
A fiat measurement is one that depends on an arbitrary or stipulated definition rather than on a confirmed theory. The weakness is that because there is no confirmed theory underlying the measurement, there can be numerous ways to construct a scale for the measurement of the given property. For example, there are different ways to measure income. Which is the proper or best way? This type of measurement is prevalent in accounting. The concept of fiat measurement was formulated by social scientists in order to justify the measurements in the social sciences; otherwise, there can be no measurement.
An inventory balance in the accounts is a derived measure because it depends on the quantity of the items and their average cost (for example). We can also argue that the inventory balance is a fiat measurement because there is no theoretically correct way to determine the balance. A company can, for example, choose between standard and average costing and there was a time that the standards allowed a choice between first-in first-out (FIFO) and last-in first-out (LIFO). These choices support the idea that the inventory balance is a fiat measurement because the measurement ‘rules’ are determined by accountants and these can change over time – they don’t represent a ‘natural law’.
In the accounting field, the standard setters have chosen to adopt what it is called a mixed measurement model. Financial statements employ the following measurement bases at different degrees and variations:
Historical cost basis of measurement requires the item to be recorded for the exact amount they have been bought, or the exact amount received or expected to be received in case of a sale. Usually these type of recording apply to transactions occurred in the past. (Rankin et al., 2012, p.93). Normally, these amounts represent the value of the item at that point in time.
“Current cost requires an item to be valued and recorded at the amount that would be paid at the current time to provide or replace the future economic benefits expected to be derived from the current item.” (Rankin et al., 2012, p.94)
Replacement cost is similar to current cost with the only difference that you need to purchase an identical item.
AASB 13 defines fair value as “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”. Being an exit value based on current market prices, this method should be more relevant in the decision making process.
Realisable value is a similar concept to fair value. The difference is that fair value rely on the market while realisable value is more entity measurement orientated. An amount recorded at realisable value is the actual amount a company expects to receive in the event of a sale; therefore it is an exit price as well. (Rankin et al., 2012, p.95)
Present value requires a process in which you need to apply an appropriate discount rate to cash flows you expect in the future from the item you need to measure. According to Rankin et al. (2012, p.95) this is a very uncertain measurement base.
Deprival value represents the loss a company would incur if being deprived of an asset. This method doesn’t hold much relevance as value is based on a scenario that may never occur. (Rankin et al., 2012, p.96)
In the Adelaide Brighton’s annual report, financial statements are prepared under the historical cost, excepting circumstances when other measurement bases have been employed and detailed in their financial accounting policies of the report. For this exercise I have chosen their latest annual report, which is for the financial year ending 30th June 2011. The following table provides details of some balance sheet items measured using different approaches.
Balance sheet item
Annual report page number
Revenue recognized as net of returns, trade allowances and duties and taxes paid
Assets classified as held for sale
Property, plant and equipment
Intangible assets -goodwill
Value in use
Under the International and Australian standards, Adelaide Brighton Limited embraced what is called a mixed measurement model. Under this approach a number of different accounting measurement bases were employed in the preparation of the financial statements.
The main reason for adopting such an approach is the need for flexibility. This model allows for use of a number of different accounting measurement bases. It is argued that this is necessary due to the differences in the substance or nature of transactions between entities and also due to the differing circumstances that entities can find themselves in. (Rankin et al., 2012, p.116)
Issues and problems associated with this approach may include variations in accounting practice – entities may choose to account for the same or similar items in different ways using different accounting measurement methods. How they measure and account for an item may be appropriate for the individual entity but could reduce comparability across entities. Also, there is the potential for different financial results being reported when different accounting measurement methods are allowed and used. Furthermore, there is the opportunity for management to make opportunistic accounting choices, creating a biased picture of reality and perhaps even misleading users.
In summary, the approach is subjective in nature. This highlights the importance of professional judgment and ethics in accounting. (Rankin et al., 2012, p.99).
1. Adelaide Brighton Limited, Annual Report, retrieved from: http://www.adbri.com.au/annualreports.html
2. Godfrey, J., Hodgson, A., Tarca, A., Hamilton, J., & Holmes, S. (2010). Accounting theory (7th ed.). Milton,
3. Goyen, M. (2012). GSB 601: Issues in company financial reporting [Topic notes]. Armidale, Australia: University of New England, Graduate School of Business. Qld: John Wiley & Sons, Australia, Ltd.vvW
4. Rankin, M., Stanton, P., McGowan, S., Ferlauto, K, & Tilling, M. (2012) Contemporary issues in accounting. Milton Qld: John Wiley & Sons Australia, Ltd.