Financial Accounting Theory

FINANCIAL ACCOUNTING THEORY
Craig Deegan
CHAPTER 5
Measurement issues: accounting
for the effects of changing prices
and changing market conditions
Slides written by Craig Deegan
Copyright 2014 McGraw-Hill Education (Australia) Pty Ltd
PPTs to accompany Deegan, Financial Accounting Theory 4e
5-1
Learning objectives
5.1 Understand what measurement means, why it is a potentially
controversial issue, and some of the factors that accounting
standard-setters might consider when prescribing a particular
measurement approach in favour of another.
5.2 Be aware of the various measurement approaches currently,
and potentially, in use.
5.3 Be aware of some particular limitations of historical cost
accounting in terms of its ability to cope with various issues
associated with changing prices and changing market
conditions.
5.4 Be aware of a number of alternative methods of asset
valuation that have been developed to address problems
associated with changing prices and market conditions,
including fair value accounting.
5-2
Learning objectives (continued)

5.5 Be able to identify some of the strengths and weaknesses
of the various alternative measurement approaches.
5.6 Understand that the calculation of income under a
particular method of accounting will depend on the
perspective of capital maintenance that has been adopted.
5.7 Be aware of the increasing use of fair value measurement
in accounting standards.
5.8 Be aware of evidence about the demand for, and
professional support of, alternative measurement
approaches.

5-3
Measurement
What is it?
According to paragraph 4.54 of the IASB Conceptual
Framework for Financial Reporting:
Measurement is the process of determining the
monetary amounts at which the elements of the
financial statements are to be recognised and carried
in the balance sheet and income statement. This
involves the selection of the particular basis of
measurement.
Measurement is obviously a very fundamental issue in
financial accounting. Measurement allows us to attribute
numbers to the items that appear in financial reports

5-4
Process of mandating a particular

measurement approach could be
controversial
When standard-setters require a particular

method of measurement in preference to others,
this can be controversial
it can have profound effects upon financial
reports, and therefore also on agreements, or
contracts, that utilise numbers from the financial
statements

5-5
Alternative bases of
measurement
There are various bases of measurement that
could be used, including:
historical cost
current costs
realisable value
present value
deprival value

5-6
Choosing between alternative

measurement bases
Determining how an asset or liability should be measured
should ideally be linked to the perceived objectives of general
purpose financial reporting
According to paragraph OB2 of the IASB Conceptual
Framework for Financial Reporting, the objective of general
purpose financial reporting is:
to provide financial information about the reporting entity that
is useful to existing and potential investors, lenders and other
creditors in making decisions about providing resources to
the entity. Those decisions involve buying, selling or holding
equity and debt instruments, and providing or settling loans
and other forms of credit.
The above perspective is often referred to as a decision
usefulness perspective
5-7
Decision usefulness versus

stewardship functions
Decision usefulness and stewardship are two terms

that are often used in relation to the role of financial
information
The decision usefulness criterion is considered to be

satisfied if particular information is useful (decision-useful)
for making particular decisions, such as decisions about the
allocation of scarce resources
Decision usefulness appears to be the focus of financial

reporting currently embraced by the IASB and FASB
An alternative focus other than decision usefulness would

be stewardship
5-8
What attributes should financial

information have for it to be decision
useful?
According to the IASB Conceptual Framework, to fulfill the

requirement that information is decision useful, financial
information should be both relevant and
representationally faithful and allow financial statement
readers to make informed resource allocation decisions
The IASB and FASBs ultimate selection of a particular
measurement base will supposedly be tied to whether a
particular measurement approach enables the above
objective of general purpose financial reporting to be satisfied
The IASB has identified three fundamental principles of
measurement that flow from the objective of financial
reporting
5-9
Three fundamental principles of measurement

As IASB (paragraph 5, 2013b) states:
The following three fundamental principles of measurement are derived from the objectives
of financial reporting and the qualitative characteristics of useful financial information as
described in Chapters 1 and 3 of the Conceptual Framework.
Principle 1 The objective of measurement is to represent faithfully the most

relevant information about the economic resources of the reporting entity, the
claims against the entity, and how efficiently the entitys management and
governing board have discharged their responsibilities to use the entitys
resources
Principle 2 Although measurement generally starts with an item in the statement
of financial position, the relevance of information provided by a particular
measurement method also depends on how it affects the statement of
comprehensive income and if applicable, the statements of cash flows and of
equity and the notes to the financial statements
Principle 3 The cost of a particular measurement must be justified by the
benefits of that information to existing and potential investors, lenders, and other
creditors of reporting that information

5-10
The use of fair value good for

assessing stewardship?
Based on the increasing use of fair value in various newly-released

accounting standards it appears that the IASB considers that measuring
many classes of assets at fair value will provide more relevant and
representationally faithful information than measuring all assets at cost
However, if by contrast, the primary objective of general purpose

financial reporting was considered to be stewardship, rather than
decision usefulness, then there is some argument that historical cost
provides a clearer perspective about what management has done with
the funds that were entrusted to it
Demonstrating how funds have been used is a key component of

stewardship. However, there is also an argument that in assessing the
stewardship of management, interested parties would not only want to
know about the original amounts spent by managers, but also about how
monies spent have increased in value, and historical cost accounting
might be deficient in this respect
5-11
Variety of measurement bases

frequently used
To this point we should understand that the
accounting standards issued by the IASB, and
therefore used within many countries globally, use
a variety of measurement bases
for example, historical cost, fair value, present value
This has been referred to as a mixed

measurement model of accounting
creates issues associated with additivity

5-12
Factors to consider in selecting between

alternative measurement approaches
The IASB and the FASB have identified a number of factors that
need consideration before a preferred approach (or a number of
approaches) to measurement is selected
According to the website of the FASB, five factors that might be
considered in selecting among alternative measurement bases
(such as historical cost versus fair value) are:
Value/flow weighting and separation The relative importance to
users of information about the current value of the asset or liability
versus information about the cash flows generated by the item, as well
as the ease and precision with which the flows can be separated from
the value changes (an indication of relevance)
Confidence level The level of confidence that can be placed on
alternative measurements as representations of the asset or liability
being measured (an indication of faithful representation)
continued
5-13
Factors to consider in selecting

measurement approaches (cont.)
The measurement of similar items Items of a similar nature

should be measured in similar ways (an indication of comparability)
The measurement of items that generate cash flows together

Items that generate cash flows as a unit should be measured the
same way (an indication of understandability)
Cost-benefit An assessment of the ratio of the benefits that would

be derived from alternative measurements to the costs of preparing
those measurements (an indication of the primary limiting factor in
financial reporting)
Obviously, as we can see from the above points, selecting the
appropriate measurement bases requires many judgments to be
made

5-14
One measurement option:

historical cost
Under historical cost
assets are recorded at the amount of cash or cash
equivalents paid, or the fair value of the consideration
given, to acquire them at the time of their acquisition
liabilities are recorded at the amount of proceeds received
in exchange for the obligation, or in some circumstances
(for example, income taxes), at the amounts of cash or
cash equivalents expected to be paid to satisfy the liability
in the normal course of business

5-15
Limitations of historical cost in

times of rising prices
Historical cost assumes money holds a constant
purchasing power
Three aspects of the economy which make the
assumption less valid than when historical cost was
developed
specific price level changes (shifts in consumer preference;
technological advances)
general price level changes (inflation)
fluctuation in exchange rates
5-16
Limitations of historical cost in times

of rising prices (cont.)
Problem of relevance in times of rising prices
assets current value may be different from historical cost
Problem of additivity (adding together assets bought at

different times)
Can overstate profits in times of rising prices, with
distribution of profits leading to an erosion of operating
capacity
Including holding gains which accrued in previous
periods in current years income distorts the current
years operating results
5-17
Support for historical cost

accounting
Predominant method used for many years so tended

to maintain support of profession
If not found useful, business entities would have
abandoned it
Nevertheless, recent accounting standards being
released have embraced fair values as the basis of
measurement. However, various assets are still
measured on an historical cost basis
e.g. inventory, which is measured at the lower of cost and
net realisable value; property, plant and equipment where
the cost model and not the fair-value model has been
adopted; many intangible assets
5-18
Definition of income
How we measure assets will be influenced by how we
define income
Income has been defined as the maximum amount that
can be consumed during the period, while still expecting
to be as well off at the end of the period as at the
beginning of the period (Hicks 1946)
Consideration of well-offness requires the stipulation of
a notion of capital maintenance
Different notions of capital maintenance will provide
different perspectives of income
different notions of capital maintenance have implications for
how assets are measured

5-19
Capital maintenance perspectives

Financial capital maintenance
perspective taken in historical cost accounting
profit earned only if money capital at the end of the period
is more than money capital at the beginning of the period
Purchasing power maintenance

historical cost accounts adjusted for changes in the
purchasing power of the dollar
Physical operating capital maintenance

profit earned if operating capacity at the end of the period
is greater than the operating capacity at the beginning of
the period
5-20
Development of accounting for

changing prices
Perceived problems associated with historical cost
in times of changing prices lead to different
proposals for change away from historical cost
Research initially related to using price indices to
restate historical costs to account for changing
prices
Literature then moved towards current cost
accounting
the basis of measurement changed to current values not
historical values
5-21
Current purchasing power

accounting (CPPA)
One alternative to historical cost was CPPA
Also called general purchasing power accounting;
general price level accounting; constant dollar
accounting
Based on the view that in times of rising prices, if
an entity were to distribute unadjusted profits
based on historical costs, in real terms the entity
could be distributing part of its capital

5-22
Calculating indices
A price index is used when applying general price
level accounting
A price index is a weighted average of the current
prices of goods and services related to a weighted
average of prices in a prior period (base period)
e.g. Australian Consumer Price Index (CPI)
Can use a general or specific price index

5-23
Performing current purchase

power adjustments
All adjustments are performed at the end of the
period
Adjustments are applied to historical cost accounts
Monetary and non-monetary assets considered
separately
values of monetary assets do not change as a result of
inflation
liabilities generally considered monetary items
continued
5-24
Performing current purchase power

adjustments (cont.)
In times of inflation, holders of monetary assets will
lose in real terms
the assets have less purchasing power at the end of the
period relative to the beginning of the period
Holders of monetary liabilities gain, given the amount

they have to repay at the end of the period is worth
less than at the beginning

5-25
Performing current purchase power

adjustments (cont.)
No change in purchasing power arises from holding
non-monetary assets
non-monetary assets are restated to current purchasing
power so no gain or loss is recognised
Purchasing power gains or losses are included in

income for the period

5-26
Movements in net monetary

assets
Must identify changes in net monetary assets as a
result of revenues or expenses
In times of rising prices there will be a loss in
purchasing power of cash received during the year
More expenses are able to be paid earlier in the
year as more cash required for expenses incurred
later in the year

5-27
Example of CPPA Adjustments

(Deegan p. 182) Calculation of gain/loss of
purchasing power of net monetary assets
Unadjusted
Index
Adjusted
Opening net monetary

assets
(10,000)
140/130
(10,769)
Sales
200,000
140/135
207,407
Purchase of goods
(110,000)
140/135
(114,074)
Payment of interest
(1,000)
140/135
(1,037)
Payment of admin
expenses
(9,000)
140/135
(9,335)
Tax expense
(26,000)
140/140
(26,000)
Dividends
(15,000)
140/140
(15,000)
Closing net monetary

assets
29,000
31,194
The difference between the adjusted closing net monetary assets and the unadjusted net
monetary assets is treated as a loss - the company would have needed to have $2194 more
to have the same purchasing power they had at the beginning of the year
5-28
Advantages of current
purchasing power adjustments
Relies on data already available under historical
cost accounting
No need to incur cost or effort to collect data about
current asset values
CPI data also readily available

5-29
Disadvantages of current
purchasing power adjustments
Movements in the prices of goods and services
included in a general price index (CPI) may not
reflect specific price movements in different
industries
Information generated under CPPA may be
confusing to users
Studies of share price reactions failed to find much
support for decision usefulness of CPPA data

5-30
Current cost accounting (CCA)

Another alternative to historical cost that was
proposed was CCA
CCA was based on actual valuations not adjusted
historical cost
Differentiates between profits from trading and
holding gains
Holding gains can be realised or unrealised
Income perspective adopted will determine whether
holding gains or losses treated as income
5-31
Treatment of holding gains or losses

under alternative capital maintenance
approaches
Financial capital maintenance perspective
holding gains or losses can be treated as income
Physical capital maintenance perspective

holding gains or losses can be treated as capital
adjustments

5-32
CCA under physical capital

maintenance approach
Advocated by Edwards and Bell
Valuations based on replacement costs
Operating income represents realised revenues
less the replacement cost of assets in question
Generates a measure of income that represents
the maximum amount that can be distributed,
while maintaining operating capacity intact

5-33
Adjustments using Edwards

and Bell approach
Adjustments usually made at year end
Historical cost accounts used as basis of
adjustments
Operating profit calculated by using replacement
costs
Holding gains excluded in calculating current cost
operating profit
not available for dividends
continued
5-34
Adjustments using Edwards and Bell

approach (cont.)
BUT holding gains are included in calculating
business profit
Business profit shows how the entity has gained in
financial terms from the increase in cost of its
resources
Depreciation of non-current assets based on the
replacement cost
As with CPPA no restatement of monetary assets
required
5-35
Advantages of current cost

accounting
Differentiating operating profit from holding gains
and losses can enhance the usefulness of
information provided
holding gains different to trading income as due to
market-wide movements that are often beyond
managements control
Better comparability of various entities

performance

5-36
Criticisms of current cost

accounting
Replacement cost of assets may not be the same
for all firms
some firms may not choose to replace the asset
If the entity requires replacement assets it may be

more efficient and less costly to acquire different
assets
Replacement cost does not reflect what the asset
would be worth if sold
continued
5-37
Criticisms of current cost accounting

(cont.)
Often difficult to determine replacement costs
Allocating replacement cost via depreciation is still
arbitrary as with historical cost accounting
Chambers (1995) claimed products of CCA were
irrelevant and misleading

5-38
Continuously Contemporary
Accounting (CoCoA)
Yet another alternative to historical cost accounting
was CoCoA
Proposed by Chambers as well as others
Based on valuing assets at net selling prices (exit
prices) at reporting dates on the basis or orderly
sales
referred to as current cash equivalent
Chambers argued that key information for decision

making relates to capacity to adapt
continued
5-39
Continuously Contemporary
Accounting (CoCoA) (cont.)
The balance sheet (statement of financial position)
considered to be the prime financial statement
shows the net selling prices of the entitys assets
Profit directly relates to changes in adaptive capital

Adaptive capital reflected by the total exit values of
assets

5-40
Capacity to adapt
Chambers approach focuses on new opportunities
the ability of the entity to adapt to changing circumstances
The ability of the firm to go into the market with cash

for the purposes of adapting oneself to contemporary
conditions (Chambers 1966, p.91)
Assumes the objective of accounting is to guide
future actions (as opposed to, for example,
stewardship)
5-41
Definition of wealth under

CoCoA
Present (selling) price is seen as the correct
valuation of wealth at a point in time
past prices are a matter of history so not relevant to
current actions
Profit is tied to the increase (or decrease) in the

current net selling prices of the entitys assets
No distinction between realised and unrealised
gainsall gains are treated as part of profit
continued
5-42
Definition of wealth under CoCoA

(cont.)
Profit is the amount that can be distributed, while
maintaining the entitys adaptive ability (adaptive
capital)
Abandons notion of realisation in terms of
recognising revenue
revenues are recognised at point of purchase or production
rather than sales

5-43
Capital maintenance
adjustment
Unlike CCA there is an adjustment to take account
of changes in general purchasing power (inflation
adjustment)
Capital maintenance adjustments form part of the
periods income with a corresponding credit to a
capital maintenance reserve (part of owners equity)
Calculated by multiplying net assets by the
proportional change in a general price index over
the period

5-44
Advantages of CoCoA
By using one method of valuation for all assets
(exit values) the resulting numbers can be logically
added together (additivity)
No need for arbitrary cost allocation for depreciation
as gains or losses on assets are based on
movements in exit price

5-45
Criticisms of CoCoA
If implemented CoCoA would involve a fundamental
shift in financial accounting
revenue recognition points and asset valuations
could lead to unacceptable social and environmental
consequences
Relevance of exit prices questioned if we do not

expect to sell the assets
continued
5-46
Criticisms of CoCoA (cont.)

Assets of a specific nature considered to have no
value under CoCoA because cannot be separately
disposed of
CoCoA ignores the value in use of an asset
Questioned whether appropriate to value all assets

at exit prices if the entity is a going concern
Determining exit prices for unique assets introduces
subjectivity into accounts
continued
5-47
Criticisms of CoCoA (cont.)

CoCoA requires assets to be valued separately
rather than as a bundle
therefore would not recognise goodwill as an asset
value of assets sold together can be very different from
separate sale

5-48
Fair value accounting
Whilst CPPA, CCA and CoCoA as just described were

proposed as alternatives to historical cost accounting, another
approach that has been adopted is to simply measure
selected assets at fair value
Fair value is an asset (and liability) measurement approach

that is now used within an increasing number of accounting
standards
In the IASBs accounting standard on fair value, IFRS 13 Fair

Value Measurement, fair value is defined 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
5-49
Fair value definition key terms

The definition of fair value uses a number of terms that
require further consideration, in particular orderly
transaction, and market participants
These terms are defined in IFRS 13 as follows:
orderly transaction A transaction that assumes exposure
to the market for a period before the measurement date to
allow for marketing activities that are usual and customary
for transactions involving such assets or liabilities; it is not a
forced transaction (e.g. a forced liquidation or distress sale)
market participants Buyers and sellers are independent of
each other, are knowledgeable, having a reasonable
understanding about the asset or liability and the
transaction using all available information, and are willing
and able to enter into a transaction for the asset or liability
5-50
How do we determine fair

values?
Fair values can be determined in different ways
Techniques that rely upon observable market values
(market prices) are often referred to as mark-tomarket approaches
Techniques that rely upon valuation models are often
known as mark-to-model approaches and require
the identification of both an accepted valuation
model, and the inputs required by the model to arrive
at a valuation

5-51
Fair value versus historical cost

In comparing fair value to historical cost, fair value is
typically considered to be more relevant to the intended
users of general purpose financial reports
However, it is a more subjective measurement basis if an
active market does not exist for an item
If a valuation model is applied because there is not an
active market then many assumptions and professional
judgments must be made
Determining fair value can be problematic when markets
are volatile, for example when there is a serious financial
crisis, or when an asset is of a type that is not regularly
traded. In such situation, managements own judgments
and assumptions will impact measurement
5-52
A fair value hierarchy

The IASBs accounting standard on fair value
measurement establishes a fair value hierarchy in which
the highest attainable level of inputs must be used to
establish the fair value of an asset or liability. As
paragraph 72 of IFRS 13 states:
To increase consistency and comparability in fair value
measurements and related disclosures, this IFRS
establishes a fair value hierarchy that categorises into three
levels (see paragraphs 7690) the inputs to valuation
techniques used to measure fair value. The fair value
hierarchy gives the highest priority to quoted prices
(unadjusted) in active markets for identical assets or
liabilities (Level 1 inputs) and the lowest priority to
unobservable inputs (Level 3 inputs).
continued
5-53
A fair value hierarchy (cont.)

Levels 1 and 2 in the hierarchy can be referred to as
mark-to-market situations, with the highest level, level
1, being (paragraph 76 of IFRS 13):
Level 1 inputs are quoted prices (unadjusted) in active
markets for identical assets or liabilities that the entity can
access at the measurement date.
Level 2 are directly observable inputs other than level 1
market prices (level 2 inputs could include market prices for
similar assets or liabilities, or market prices for identical
assets but that are observed in less active markets).
Level 3 inputs are mark-to-model situations where
observable inputs are not available and risk-adjusted
valuation models need to be used instead.
5-54
Fair values and its relationship to

volatility and procyclicality in
accounting measures a problem?
A quantity or measure that tends to increase when
the overall economy is growing, or decreases when
the economy is declining, is classified as being
procyclical
During the sub-prime banking crisis it was claimed
by many (especially banks themselves) that
accounting requirements as reflected in various
accounting standards that require reporting entities
to measure many of their assets at fair value actually
exacerbated the financial crisis
continued
5-55
Procyclicality attribute of fair values

(cont.)
It is argued that when markets for financial assets
(such as shares, bonds and derivatives) are booming,
the value of these assets held by banks, and shown at
fair value within their statements of financial position,
will similarly rise significantly above their historical
cost thus increasing the reported net assets and
capital and reserves of the bank
As banking regulations usually set bank lending limits
in terms of a proportion (or multiple) of capital and
reserves, this increase in the reported fair value of the
assets of a bank will enable a bank to lend more
continued
5-56

(cont.)
Some of this additional lending will fuel further
demand in the markets for financial assets thus
further increasing the market values/prices of these
assets held by banks and further increasing their
reported capital and reserves
This, it is argued, will enable banks to lend even
more and thus will help to create an upward spiral in
financial assets prices, and bank lending, that
becomes increasingly disconnected from the
underlying real economic values of the assets in
these markets
continued
5-57

(cont.)
Conversely, it has been argued that at the time of the sub-prime banking
crisis when markets for financial assets were in free-fall, fair value
accounting exacerbated a downward spiral of asset prices and bank
lending that is equally unreflective of (and significantly overstates)
decreases in real underlying economic values
Requirements to mark-to-market financial assets held by banks may lead

to a rapid erosion in the capital and reserves shown in the banks
statements of financial position
This will reduce their lending limits and will both reduce bank lending
(thus reducing demand in financial markets, putting further downward
pressure on the assets prices in these markets) and possibly require the
banks to sell some of the financial assets they hold to release liquidity
This will put further downward pressure on the asset prices, leading to a
downward price spiral as these reduced prices further reduce the
reported net assets of the banks
continued
5-58

(cont.)
Although these impacts of fair value accounting were widely articulated at

the time of the sub-prime banking crisis, Laux and Leuz (2009) argue
many of these claimed empirical effects were not caused by fair value
accounting, so the volatility and procyclicality case against fair value
accounting is not as clear cut as the above arguments indicate
IFRS permit fair values to be determined using data other than direct
market observations in many circumstances for example level 2 and
level 3 in the fair value measurement hierarchy
In situations where markets are demonstrably not providing values based

on orderly transactions, or are for any other reason not operating
efficiently (for example due to illiquidity in the markets), then rather than
using level 1 fair value measurements (directly observed market prices
for identical assets), then level 2 mark-to-market or level 3 mark-to-model
valuations should be used
continued
5-59

(cont.)
Laux and Leuz (2009) explain that during the sub-prime banking crisis,
many banks moved to using level 2 and 3 valuations rather than level 1
valuations for many financial assets, and also took advantage of
provisions to allow some assets to be reclassified from fair value to
historical cost categories in special circumstances, thus acting as a
damper, reducing the speed (or acceleration) of any procyclical effects
They also argue that any failure to provide fair values in financial
statements during economic downturns could in itself cause markets to
overreact and/or misprice company shares
Hence, there are arguments for and against the position that the use of
fair values contributed to the impacts of the global financial crisis
Nevertheless, an interesting issue for accounting standard-setters to

consider did fair values contribute to the global financial crisis and
therefore to various social and economic problems of the time?

5-60
Demand for price adjusted and value

adjusted accounting information
Earlier we discussed various normative theories of
accounting (CPPA, CCA, CoCoA)
Limited evidence that stock markets react to current
cost and CPPA information
little or no share price reaction to price adjusted accounting
information found
results may have been due to limitations with research
methods used
reaction to other information released at the same time could
not be distinguished
users may have obtained information from other sources prior
to release of annual reports
continued

5-61
Demand for price adjusted accounting

information (cont.)
Surveys of managers find limited corporate support
for current cost accounting
cost, limited benefits from disclosure and lack of
agreement as to approach are all considerations
Surveys of users indicate information not helpful,

not used and information does not tell users
anything new
Findings interesting given the extent of voluntary
disclosure by corporations
5-62
Reasons for lobbying

Watts and Zimmerman examined lobbying reaction
to the release of FASB Discussion Memorandum
on general price level accounting
Found that political visibility is a major factor in
explaining lobbying positions
large firms favour general price level accounting as leads
to lower reported profits
continued
5-63
Reasons for lobbying (cont.)

Supported in New Zealand by Wong (1988)
corporations adopting CCA during period of rising prices
had higher effective tax rates and larger market
concentrations than those that did not
In UK Sutton (1988) found politically sensitive firms

more likely to lobby in support of exposure draft
recommending disclosure of CCA

5-64
Professional support for

various approaches
Current purchasing power accounting generally
supported by standard-setters from 1960s to mid1970s
From about 1975 preference shifted to current cost
accounting
Late 1970s and early 1980s standard-setters issued
recommendations which favoured a mixture of CPPA
and CCA
From mid-1980s support waned (time of falling
inflation)
5-65
Potential reasons for lack of

continued support
May question the relevance of current cost
information in times of falling inflation
Drastic change to accounting conventions could
cause disruption and confusion in capital markets
New method of accounting could have taxation
consequences
continued
5-66
Potential reasons for lack of continued

support (cont.)
Self-interest motives of corporations
Limited relevance to decision makers
Nevertheless, in recent years there have been
movements towards the use of fair values as
new accounting standards are being released

5-67

Financial Accounting Theory

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FINANCIAL ACCOUNTING THEORY

Learning objectives (continued)

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Process of mandating a particular

When standard-setters require a particular

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Choosing between alternative

Decision usefulness versus

Decision usefulness and stewardship are two terms

The decision usefulness criterion is considered to be

Decision usefulness appears to be the focus of financial

An alternative focus other than decision usefulness would

What attributes should financial

According to the IASB Conceptual Framework, to fulfill the

Three fundamental principles of measurement

Principle 1 The objective of measurement is to represent faithfully the most

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The use of fair value good for

Based on the increasing use of fair value in various newly-released

However, if by contrast, the primary objective of general purpose

Demonstrating how funds have been used is a key component of

Variety of measurement bases

This has been referred to as a mixed

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Factors to consider in selecting between

Factors to consider in selecting

The measurement of similar items Items of a similar nature

The measurement of items that generate cash flows together

Cost-benefit An assessment of the ratio of the benefits that would

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One measurement option:

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Limitations of historical cost in

Limitations of historical cost in times

Problem of additivity (adding together assets bought at

Support for historical cost

Predominant method used for many years so tended

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Capital maintenance perspectives

Purchasing power maintenance

Physical operating capital maintenance

Development of accounting for

Current purchasing power

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Can use a general or specific price index

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Performing current purchase

Performing current purchase power

Holders of monetary liabilities gain, given the amount

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Performing current purchase power

Purchasing power gains or losses are included in

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Movements in net monetary

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Example of CPPA Adjustments

Opening net monetary

Closing net monetary

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Current cost accounting (CCA)