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Identify and evaluate 5 accounting measurement systems [25]
a) Define ‘measurement’ in the context of accounting
Entities measure their assets and liabilities from time to time using various
measurement basis. The IASB’s Conceptual Framework defines measurement
basis in that regard as ‘the concept that is used in determining the amount at
which an asset or liability is stated in the financial statement’ (IFAC, 2021).
There are two major measurement models which are the historical cost model
which consist of the historical cost measurement basis as well as the current
value model which has the fair value basis, ……….. The historical cost model
is used for initial recognition whilst the basis under the current value model are
for the subsequent measurement. The IASB does not prescribed a measurement
base or basis to be used by an entity for a certain transaction or event. Rather,
the entity chooses a measurement base or basis that best results in quality
information for the users of the financial statements. This essay will then
identify and evaluate the accounting measurement systems mentioned above.
Historical Cost Measurement
Historical cost is defined as ‘the consideration given to acquire or develop an
asset, which is the cash or cash equivalents, or the value of the other
consideration given, at the time of its acquisition or development’ (IFAC,
2021). Historical cost is considered to be the most objective as assets are
recorded at the cost incurred on their acquisition without any human judgement
in coming up with the value. Assuming company A bought office furniture at a
price of $5 000 then that is the amount recorded as the value of that asset in the
financial statement. Likewise, liabilities recorded at cost are also recorded as the
amount received in the transaction under which obligation is assumed. For
example, if company B accepts a payment worth $3 000 for a service to be
rendered at a later date, the liability is recorded in the financial statement at the
same value.
One of the advantages of historical cost measurement is that it is less subjective
than other measurement basis therefore less prone to manipulation, making it
verifiable easily. This is because the value of the asset is recorded as it is, being
the value of the consideration given up to acquire the asset, without human
judgement in trying to come up with the value of the asset.
It also provides consistency and comparability between companies. For
example, companies A and B acquire an asset on the same date at the same
price, using historical cost measurement, the asset is recorded at that same value
in the financial statements of both companies thereby allowing consistency and
comparability between companies. Unlike using, for example fair value
measurement, a similar asset might be valued at different amounts by
independent valuers which then makes it impossible to compare the financial
statements of different entities.
However, this cost measurement basis also has its shortcomings. One of such is
it does the inability of the method to take into consideration inflation,
depreciation and capital expenditure to the asset. And as such, the information
might end up irrelevant and of little to no value to the users of the financial
statements. The asset might have increased or decreased in value but the
historical cost measurement does not adjust the values to match the true values
in the market.
The historical cost model does not comply with the matching principle which
entails that an entity’s revenue should be matched with the expenses related to
earning those revenues. This is because the method does not take into account
the changes in value of the assets and liabilities. For example, a machinery
recorded at cost at a value of $10 000 but the entity realising revenue valued at
$50 000 from the use of such an asset. And thus, making it difficult to get an
accurate picture of the company’s financial status.