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7) measurement issues

7) measurement issues - 7 Measurement Issues in Financial...

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7) Measurement Issues in Financial Reporting Why Does Measurement Matter? It is the basis for performance evaluation Contractual relationships are often framed around measurement (e.g. executive remuneration) The cost of capital is linked to measurement Taxation is usually based on measured performance Often, companies have to make choices about measurement bases Measurement Terminology Initial measurement – The value attributed to an asset when first acquired or to a liability when first incurred Re-measurement – e.g. revaluation or write-down for impairment Entity - specific – Values specific to a reporting entity Mixed measurement – Use of more than one basis of measurement within a set of financial statements Entry value – Cost-based value (historic cost or current replacement cost) Exit value – Sale value (net realisable value) Value in use – The PV of future cash flows Deprival value – The loss an entity would suffer if deprived of the use of an asset (the lower of replacement cost and recoverable amount which is the higher of net realisable value and value in use) What is Fair Value Accounting (FVA)? All assets and liabilities should be measured at ‘fair value’ – prices set by willing and independent buyers in the free market All gains and losses arising from changes in fair values should be recognised immediately in the income statement. FVA is an ‘asset-liability’ approach rather than a ‘revenue-expenditure’ approach which reflects the view that income represents the change in net economic assets. Historical Cost vs. Fair Value Accounting Historical cost accounting (HCA) has been around for a long time and is very established, yet many would argue that FVA is superior. FVA results in more consistent measurement and presentation and offers fewer opportunities for the manipulation of financial statements For a wide range of stakeholder groups, FVA provides more relevant information than HCA for making financial decisions and exercising stewardship
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Fair values for assets reflect current market conditions and hence provide timely information, increasing transparency and encouraging prompt corrective actions HCA is not useful in assessing company value, and leads to conservatism at the expense of relevance HCA is a particularly unsuitable method of accounting measurement during inflationary periods FAS 157: Consolidated Guidance on Fair Value
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7) measurement issues - 7 Measurement Issues in Financial...

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