CHAPTER 6

ACCOUNTING
MEASUREMENT SYSTEM
Kelompok 3
Akib Panduarbyanto
1506798926
Deriqqa Mawaddah
1506799140
M. Abdul Rafi Zakir
1506799544
Theodorus A. Adiatma 1506799992

Income and Capital

Measurement System
Historical Cost

Current Cost

Emerged in 1930 (after the collapsed of

Wall Street in 1929)

Emerged in 1960

Proposed by Edward and Bell

Notion of Fair Value measurement system

Historical Cost

Objective of Accounting
To provide investors and creditors a report to ensure
what management has done
Historical Csults ost (HC) objective emphasises a
conservative contractual relationship between firm
and its resources providers to it by making
management accountable for the input of asset to
operation and the subsequent output on the net
value of operation
Critics : HC only report income without recognition
of the changing value of asset and liabilities. Thus, a
misleading and result in incorrect dividend policies

Capital and Profit

Capital

Must be retained the same amount (asset

liab.) that it had at the beg.period where
all assets and liabilities at their purchase
cost

Income

Reflects accomplishment of the firm for

given period, expenses which represent the
effort expanded and profit correlates with
the effectiveness of the firm in operationg
unit

Matching of cost theory

Accountant must trace the movement of cost
and match them to whether revenues received
or cost have expired on income statement

Conservatism
Any potential revenues streams flow into
the income statment slowly over time

Arguments for HC
More relevant in decision
making
Based on actual, not
merely possible
Through history, financial
statement based on HC
have been more useful
The best understood
concept of profit is the
excess of selling price
over HC

Accountant must guard the integrity of their

data against internal modification

How useful is profit information based on

market value?
Changes in market prices can be disclosed
as supplementary data

There is insufficient evidence to justify

rejection of HC

Criticism of HC
The objective -> information on the stewardship
function does not necessarily restrict accountability
to the original amount invested.
Information for decision making -> Profit under HC
measurement has no such prospective intepretation
Basis of HC -> Matching (offset) concept is a
practically impossible
Notion of investor needs -> accounting should
provide information for intelligent investor who is
interseted in whats really going on in the business

Objective of current
cost accounting
CCA is an Accounting system in which assets are valued at
current market buying prices and profit is determined by
allocation based on current costProfit is more precisely
defined as the change in capital over the accounting period.
Managers are better able to evaluate their past decisions
and better use the firms resources to maximise future
profits.
Shareholders, investors and others are able to make better
allocations of their resources.
Evaluation by both insiders and outsiders provides the
means for the successful functioning of economy, because
resources will then be allocated more efficiently.
10

Concept of Busines Profit

and Financial Capital
With regard to profit, management often
faces two decisions
Holding decisions: about whether to hold assets
and liabilities or to dispose them.
Operating decisions: about how to use and
finance the entitys operations.

Edward and Bell offer a profit concept that

they call business profit comprising current
operating profit and realisable cost
savings.
11

Why Holding Gains are

Component of Profit?
Edwards and Bell believe that holding
gains represent a saving attributable to
the fact that the input was acquired in
advance of use.
Another possible justification for the
inclusion of holding gains as profit is to
say that the appreciation of value is an
actual economic phenomenon that could
realised if the firm were to sell the
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asset.

Financial capital versus

physical capital
Profit is the change in capital.
Holding gains are included in profit
under financial capital.
Holding gains are excluded from profit
under physical capital.
Under market value accounting
systems, the calculation of profit
depends on the measure of capital.
13

Arguments for and

against current cost
Recognition principle
violates the conservatism principle - but
actual phenomena
are holding gains profits or revaluation
adjustments?

Objectivity of current cost

lacks objectivity
Technological change
appears to ignore technological advances
14

More specific
criticisms
Advocates of historic cost accounting
violates the realisation principle; subjectivity of increase

Comparisons of the results with historic cost

industry variations

Advocates of exit price

the logical expression of opportunity cost is the current selling price

the arbitrary allocation of expenses is still a problem issue
additivity problem exists
number of reasons for an asset having value to a business
irrelevant to most business decisions
physical capital concept fraught with weaknesses

15

Exit price accounting

System of accounting wich uses market
selling prices to measure firms financial
position and performance
Major departures from historic cost
accounting:
the values of non-monetary assets are
adjusted to measure changes in market
selling prices and any changes are included
in profit as unrealised gains

changes in the general purchasing power of16

money taken into consideration when
measuring financial capital and the result of

Exit price accounting

Represents clean surplus accounting;
profit is measured under
comprehensive concept wich
measures the total real change in the
value of all recognised elements of
equity
The income statement explains all of
the differences existing between the
opening and closing balance sheets
17

Objective of accounting
Objective of accounting is to provide data for
adaptive decision making
The assumption is that the business world is
dynamic and business must adapt to survive
Firms and those associated with them go into
markets to take advantage of opportunities as
they arise
The ability to engage in market transactions is
revealed by net financial position (net current
market value)
Ultimately all accounting information users are
interested in cash and cash equivalent values
In the final analysis, the economic survival and
performance of a firm depends on the amount of
cash it can command
18

Arguments for exit

price accounting
Provides relevant and reliable information
there is one way to determine profit that is
superior to all others
profit is the difference between capital at two points
in time exclusive of additional investments by and
distributions to owners

to be relevant, information must be useful in

the decision models of accounting data users
the present selling price is the only item of
information that is relevant to all decisions
19

Arguments for exit

price accounting
Additivity
if we assign different values to different
measurement scales, then no practical
meaning can be deduced from aggregate
even if we use historic cost accounting as
the sole measurement system, the jumble of
historic costs on different dates means we
cannot put any meaning on the calculation of
net assets or profit
exit price accounting does not have this
problem
20

Arguments for exit

price accounting
Allocation
The income statement is not a report of changes in
allocated amount. The financial statements are
allocation free

Profit displays the amount of change in real

purchasing power of the net assets

Reality
Exit prices accounting involves references to the
real-world in that every disclosed amount refers to a
present actual market price

exchangeability
21

Arguments for exit

price accounting
Objectivity

market prices are relatively more objective

A measure of risk
can indicate the financial risk of purchasing
an asset

22

Arguments against exit

price accounting
Profit concept
does not provide a meaningful concept of profit.
Meaningful concept of profit is the measurement of
performance in terms of what was originally
intended
the critical event does not relate to the performance
of the firm
does not produce realistic financial reports

Additivity
violates the principle of exclusion of anticipatory
calculation that it claims to reject
23

Arguments against exit

price accounting
The valuation of liabilities
valuing liabilities at face value and
not market value is internally
inconsistent

Current cost or exit price

at what stage of the operating cycle
should exit price dominate asset
valuation?
24

Value in use versus

value in exchange
Similar when markets are liquid and
efficient
There are factors common to both
market prices are more relevant for decision making
additivity and reliability are prime requirements
historic cost accounting has too many defects

They are complements not substitutes

Value in use assesses long term survival
(solvency), value in exchange assesses the
ability to adapt in the short term (liquidity)
25

Current Cost in the

United States
o In 1976, the US Securities Exchange Commission (SEC)
amended Rule 3-17 of Regulation S-X to require that
replacement cost data be disclosed in the filed 10-K reports by
firm with inventories and productive assets totalling more than
US$100 million and constituting more than 10 per cent of total
assets, and was published in Accounting Series Release (ASR)
190.

o In 1979, FASB repealed ASR 190 and issued Statement 33

requring supplementary disclosures of general inflation
adjusted accounts and current costs data, and it issued
Statement 89 in 1986, rescinding the requirement but urging
copanies to continue diclosing the data. But in November 1984,
in Statement 82, the FASB eliminated that standard
requirement

Current Cost in United

Kingdom
In 1975, the Sandilands Committee,
recommended a system of current cost
accounting instead of historical because of it
limited and usefulness information
In March 1980, the Accounting Standards
Committee issued a statement (SSAP) 16 on
current cost accounting, and the standard
applied to listed and large companies but in
1985 the ASC withdrew the mandatory status
of SSAP 16

Current Cost in Australia

The Accounting Profession issued DPS
1.1, Statement of Provisional
Accounting Standards (PAS), Current
Cost Accounting, in October 1976, and
an amended version of PAS 1 and a
working guide were issued in August
1978.
But, because of downgrading
implementation of SAP (Statement of
Accounting Practice) 1, Currect Cost
Accounting, it was not widely adopted in

International accounting standard and

current cost

On 15 July 2004, the AASB Voted to adopt

international accounting standards for all reporting

entities preparing general purpose financial reports
after 1 January 2005. IASB standards make greater
use of fair value measurement than some national
GAAP

Fair value is normally the current transaction price

and if there is no active market then a number of
surrogates of fair value can be used such as
discounted cash flows, option pricing models, market
indexes, appraisal value, and depreciated
replacement cost (eg. IAS 39)

Fair value is accepted as the market transaction prie,

the definition of a transaction cost is not consistent
and a single transaction price is not consistenly in
IFRS (eg. IAS 16)

Under international accounting standars, the

definition of fair value can vary substantially and
there is no mention in the standards of capital

How is historical cost applied and

historical cost under attack
Subjectivity is involved in the determination of
the acquisition cost of an item
Thereafter the measurements are even more
subjective
The period when historical cost attack
The era of historic cost accounting has ended
it produces irrelevant, unreliable, noncomparable and non-understandable data

A mixed measurement system

and international standards
Market values - exit prices - are
implied in the fair value approach in
international financial reporting
standards
A lack of a theoretical concept of
valuation, capital maintenance and
profit measure, has resulted in a still
mixed measurement system and a lack
of consistency

Issue for Auditors

Auditors must contend with a mixed measurement
model, because for any one entity the measurement
bases could include at a minimum, fair values,
dicounted cash flows, and amortised costs, and that
vary remains complex issues.
Auditors need to obtain sufficient and appropiate
evidence on the fair presentation and compliance of
financial statements, thus, auditor must seek evidence
from other sources, such as expert opinions from
appraisal, test the basis of management assumption to
assess the future economic benefit, and seek additional
evidence from related parties.