Hello, dear friend, you can consult us at any time if you have any questions, add WeChat: THEend8_
ACCT2011
Reporting on Business Performance Module 2: Measurement; Choice of Accounting Methods By Timothy Wang Measurement; Choice of Accounting Methods Text Readings: – H&P Chapters: – Ch 3 pp. 58 & 60-61; – Ch 4 pp. 98-105; and – Ch 5 pp. 118-139. Other Readings: – “Financial Reporting” 3rd ed, Loftus et al. (2020), pages 30-32 – AASB Conceptual Framework – AASB 13: Fair Value Measurement – AASB108: Accounting Policies, Changes in Accounting Estimates and Errors – Conceptual Framework for Financial Reporting, IFRS Conceptual Framework Project Summary, March 2018
Learning objectives Measurement & Fair Value: 1. Describe measurement in the context of accounting (H&P LO 3.4, H&P pages 58 & 60-61, Loftus et al pages 30-32 ) 2. Describe the importance of fair value measurement (H&P LO 4.1, H&P pages 98-100) 3. Define fair value and describe its various components (H&P LO 4.2 – 4.2.4, H&P pages 100-105)
Learning objectives Choice of Accounting Methods: 4. Explain the process used by accounting standard setters to make choices between alternative accounting policies (H&P LO 5.1, H&P pages 118-122) 5. Discuss reasons why choices of accounting policies are available to preparers of financial statements and the attempts by Australian accounting standard setters to limit this choice (H&P LO 5.2, H&P pages 122-123) 6. Explain ‘creative accounting’ by preparers of financial statements (H&P LO 5.3, H&P pages 123-125), and understand what is meant by ‘earnings management’ 7. Discuss preparers of financial statements incentives to engage in earnings management (H&P LO 5.4 & LO 5.5, H&P pages (125-139)
Objective 1 Describe measurement in the context of accounting* (H&P LO 3.4, H&P pages 58 & 60-61, Loftus et al pages 30-32) *The following information is based on the AASB Conceptual Framework
Measurement in accounting AASB Conceptual Framework - Broad definition of measurement: “the assignment of numerals to objects or events” (H&P p.58). - Accountants use money to measure, so all accounting measures have a dollar sign. – Elements of financial statements could be measured in many ways: – Historical cost; – current (replacement cost); – Fair value; – Net realisable (settlement) value; – present value. Refer to Table 1.1 Loftus et al page 30 – . Entry price Exit price Also called cost-based amount
Measurement in accounting – AASB Conceptual Framework lists these measurement bases but does not decide. – These are all financial measures, but which should be used? – But to be able to aggregate the measures, i.e. to add them, or subtract them, the measures need to be the same. – If, for example, we use historical cost for some items and realisable value for others, the totals are not meaningful. – In accounting practice, multiple different measures are used for different types of elements (eg. Accounts receivable, plant and equipment). - Measurement basis is important - When you see a company’s total assets, what does that total mean?
Measurement baseAccounts Active Learning: Inventory The lower of cost and net realisable value Net accounts receivable Amortised cost/expected cash receipts Property, plant and equipment Modified historical cost/cost-based amount A mixed measurement system
Measurement in accounting Example 1– Different measurement bases Source: H&P page 61 Do 1 dollar in 2007 and 1 dollar in 2017 have the same purchasing power Because of inflation?
Measurement in accounting Factors to consider when choosing a measurement basis AASB Conceptual Framework – Choice of a measurement basis is a professional judgment based on the facts and circumstances for each account balance – For “relevant” consider characteristics of the asset or liability and its related income/expense and contributions to future cash flows – For “faithfully represent” consider consistency/inconsistency of measurement basis between related asset and liability accounts, will financial statement users find the information useful and does it faithfully represent the underlying transactions – Hans Hoogervorst, Chair of the IASB, provides an overview of the RCF approach that has been adopted by the AASB
IASB Conceptual Framework - Measurement Source: Conceptual Framework for Financial Reporting, IFRS Conceptual Framework Project Summary, March 2018
IASB Revised Conceptual Framework - Measurement Source: Conceptual Framework for Financial Reporting, IFRS Conceptual Framework Project Summary, March 2018
Objective 2 Describe the importance of fair value measurement (H&P LO 4.1, pages 98-100) Fair value – Accounting standard setters have increasingly been using 'fair value' as a measure in various accounting standards. (see list H&P p. 98). – What is fair value? – The exit or selling price of an asset (or the price paid to transfer a liability) at the measurement date. – Fair values change as market prices change. – If changes in fair value are recognised in financial statements, they will affect the financial performance and financial position of the entity. – Although fair values have been used in Australia for many years for property, plant and equipment (Modules 3-4), standard- setters’ efforts to apply fair values to financial instruments have received significant attention and has been most controversial.
Criticisms of fair value – Fair value can be unreliable, especially when there is no active market to provide evidence of fair value. – Fair values might not be relevant under some circumstances, and so recognition of unrealised gains or losses might be misleading. – During global financial crisis (GFC) of 2007-2009, it was argued that fair value accounting caused the GFC. (Not correct, but the accounting standard setters were placed under pressure and made some changes).