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MEASUREMENT THEORY
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Campbell:
The assignment of numerals to representproperties of material systems other than
numbers
2
Importance ofmeasurement
Assignment of numerals to objects or events
according to rules. (Stevens)
Assignment of numerals to objects or events
according to rules. (Stevens)
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Involves linking the formal number systemto some property of objects or events bymeans of semantic rules◦ e.g. semantic rules in accounting are represented
by transactions
In accounting we measure prot by:◦ rst assigning a value to capital
◦ then calculating prot as the change in capitalover the period
3
Importance ofmeasurement
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We eamine the relationship between the fair value measurement and theaudit !uality. "ur evidence suggests that the fair value measurement has anegative impact on the overall C#$s% audit !uality. $nd this negative e&ectdepends on the application scale of the fair value measurement.'owadays( large)scale application of the fair value measurement doesdecrease the overall audit !uality( but a modest application re*ects the
intention of improving the value relevance of accounting information andplays its proper role.
They should pay more attention to the audit of fair value and reduce theadverse e&ect of fair value measurement on eternal audit( so that thismeasurement can play its proper role as soon as possible.
Provide will dier and dierentdecisions
INTL Page 31 4
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#!at is t!e MeasurementApproac!$
+reater ,se of Current -alues in the inancial/tatements #roper
Two versions of current value◦ 0it price: /$/ 123 denes fair value as eit price
◦ -alue)in)use: present value of future cash receiptsor payments
4ole of measurement approach is to increasedecision usefulness over that of informationapproach
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#!% are Accountants Movin&Towards a Measurement
Approac!$
/ecurities markets may not be ase5cient as previously believed◦
To etent markets not fully e5cient( ameasurement perspective is supported 6ow 47
◦ 8etter measurement may increase accounting9market share in eplaining share price
changes
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#!% are Accountants Movin&Towards a Measurement
Approac!$
"hls;n%s clean surplus theory◦ $ theoretical framework supportive of a
measurement approach
$uditor 6iability◦ 8etter measurement may reduce auditor
liability when rms become nancially
distressed
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Are Securities Mar'ets (ull%E)cient$
8ehavioural nance◦ 8ehavioural characteristics that !uestion market
e5ciency 6imited attention
"vercondence
4epresentativeness
/elf)attribution bias
6eading to momentum
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0very measurement is made on a scale Created when a semantic rule is used to
relate the mathematical statement toobjects or events
The scale shows what information thenumbers represent
1
Scales
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Semantic Rules and MeasurePro*t
11
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'ominal scales◦ 'umber used only for labels<
◦ 'umbers represent classications<
◦ e.g. the classication of assets and liabilitiesinto di&erent classes
"rdinal scales
◦ 4ank orders objects with respect to a givenproperty
◦ Intervals between the numbers are notnecessarily e!ual
12
Scales
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Interval scale◦ 4ank orders objects with respect to a given
property◦ The distance between each interval is e!ual and
known◦ $n arbitrarily selected =ero point eists on the
scale e.g. celsius temperature scale e.g. standard cost accounting
4atio scale◦ 4ank orders objects with respect to a given
property◦ Intervals between objects are known and e!ual
13
Scale
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Nominal Scales
14
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Intl 2! 1"
RATIO SCALE
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There must be a rule to assign numbersbefore there can be measurement
The formulation of the rules gives rise to ascale
?easurement can be made only on a scale
1$
T%pes of measurement
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'umbers are assigned by reference tonatural laws
undamental properties are additive◦ e.g. length( number and volume
In accounting there is considerable debateover the nature of fundamental value
1!
(undamentalmeasurements
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Is one that depends on the measurement oftwo or more other !uantities
@epends on known relationships tofundamental properties◦ e.g. the measurement of density depends on the
measurement of both mass and volume
◦ e.g. the measurement of prot depends on themeasurement of both income and epenses
1%
"erived measurements
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Typical in social sciences includingaccounting
8ased on arbitrary denitions ) e.g. of prot
'umerous ways in which scales can beconstructed ?ay lead to poor levels of condence in the
scale > e.g. there are hundreds of ways to
measure prot
2
(iat measurements
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'o measurement is free of error eceptcounting◦ e.g. we can count the chairs in a room and be
eactly correct
21
Relia+ilit% and accurac%
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What is reliable measurementA◦ proven consistency
◦ repeatable or reproducible
◦ precision
4eliability incorporates two aspects◦ accuracy and certainty of measurement
◦ representative faithfulness
22
Relia+le measurement
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Intl 2% 23
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?any accounting measurements are on aratio scale
This is the most informative scale
Weakest theoretical foundation as they areat measurements
2"
Accurate measurement
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The sources of error include the following: ?easurement operations stated imprecisely ?easurer Instrument 0nvironment $ttribute unclear 4isk and uncertainty
We need to establish limits of acceptableerror
2#
Sources of error
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2$
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2!
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Two fundamental measures◦ capital prot
Capital and prot can be dened derivedin various ways
Concepts of capital prot have changedover time◦ number of concepts of fundamental measurement
2%
Measurement inaccountin&
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Two notable developments in internationalstandards D7EE2( I$/8F◦ prot measurement and revenue recognition
should be linked to timely recognition
◦ the fair value approach should be adopted as theworking measurement principle
At no stage has the principle of capital
maintenance been explicitly discussed
3
Measurement inaccountin&
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The focus of prot measurement has shiftedfrom matching revenues and epenses toassessing the changes in the fair value ofnet assets◦ e.g. immediate recognition of impairment losses
$uditors must determine whethermanagement has made appropriate andreasonable valuations◦ e.g. at least 17 methods of valuing intangibles
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Measurement issues forauditors
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It is possible for several di&erent butreasonable measurements and impairmentlosses to be recognised by management
These would all be acceptable to an auditorif management have◦ applied the valuation models correctly
◦ used appropriate data
◦ made appropriate assumptions
◦ acted in a consistent manner
32
Measurement issues forauditors
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Intl 2$ 33
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Main income and capitalmeasurement s%stems
The historic cost accounting system current cost accounting
34
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Historic cost accountin&
/eparation of ownership and control◦ information asymmetry
?ost critical objective of accounting isaccountability ) stewardship DconservatismF
The income statement is paramount◦ transaction based
◦ revenue recognition
◦ matching
◦ prot measurement
3"
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Ar&uments for !istoric costaccountin&
4elevant in making economic decisions 8ased on actual( not merely possible(
transactions @ata have been concept of prot ?ust guard data against internal
modicationsfound to be useful The best understood #rot based on alternatives may not be useful ?arket prices can be supplementary data Insu5cient evidence to reject it
3#
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,riticisms of Historical,ost "bjective of accounting Information for decision making 8asis of historic cost
?atching 'otions of investor needs
3$
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O+-ective of current costaccountin& CC$ values assets at their current market buying price
and prot is determined using matching epenseallocations based on the current cost to buy
#rot is more precisely dened as the change incapital over the accounting period
?anagers are better able to evaluate their pastdecisions and better use the rm%s resources tomaimise future prots
/hareholders( investors and others are able to make
better allocations of their resources ?anagers will eamine
3!
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Ar&uments for and a&ainstcurrent cost
4ecognition principle◦ violates the conservatism principle ) but actual
phenomena
◦ are holding gains prots or revaluation
adjustmentsA "bjectivity of current cost
◦ lacks objectivity
Technological change◦ appears to ignore technological advances
3%
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International accountin&standards and current costs
I$/8G$/8 have agreed that fair value isthe best measurement basis D7EEHF◦ the amount for which an asset could be
echanged( or a liability settled( between
knowledgeable( willing parties in an arm%slength transaction
4
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A mi.ed measurement s%stemand international standards
?arket values ) eit prices ) are implied inthe Bfair value% approach in internationalnancial reporting standards
$ lack of a theoretical concept of valuation(capital maintenance and prot measure(has resulted in a still mied measurementsystem and a lack of consistency
41
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Issues for auditors
The mied measurement model createsmisstatement so that auditors struggle tomeet one of their primary objectives◦ determining whether the nancial statements
present a true and fair view
42
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Auditor /ia+ilit%
Will a measurement approach reduce auditorliabilityA◦ #erhaps( if investors subject to limited attention $uditor can claim that the nancial statements proper
anticipated value changes 8ut( current values may be subject to
manager bias if no market value available Then( may be hard to resist manager bias
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Auditor /ia+ilit% and,onservative Accountin&
0ample: conditional conservatism◦ $ change in asset value has already occurred
◦ $ssume investor is risk averse
◦ Investor opportunity loss of epected utility if adecline in asset value is not recorded 1.E7
◦ Investor loss if an increase in asset value notrecorded .27
◦ Investor more likely to sue auditor if a decline in
asset value not recorded.◦ $uditor reaction: conservative accounting( to
reduce likelihood of lawsuit
Continued
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Auditor /ia+ilit% and ,onservativeAccountin& 0continued1
0ample: unconditional conservatism
◦ $sset value J1E(EEE at nancial statement date(but value may change in future If asset declines in value( investor loses utility of 1.E7
If asset increases in value( investor loses utility of .2H
Kow should auditor value asset at statement dateA
◦ If asset valued at J1E(EEE Dcurrent valueF( investorepected utility LM.ML
◦If asset valued at JM(HEE Dconservative valuationF(investor epected utility HE.EE
This suggests an investor demand forconservatism
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,onclusions
$ssuming reasonable reliability( current valueaccounting can increase decision usefulnessrelative to information perspective
Increased use of current value accounting in
nancial reporting◦ 4easons
?arkets not fully e5cient
6ow eplanatory power of net income for share returns
"hls;n clean surplus theory $uditor liability
@ecision usefulness for investors may befurther increased by conservative accounting