Importance of Measurement in Accounting - Essay Example

Discuss issues in accounting measurement Affiliation Discuss issues in accounting measurement Introduction Measurement is vital inaccounting and to accountants because it enables them to record, summarize and report financial transactions, as well as prepare financial statement that indicate the actual position of the organization. Financial reports are imperative for any organizations because they provide useful information to present to potential investors, stakeholders and creditors among other interested parties when it comes to decision making on making investments, credit and allocation of funds. Although accounting measurements are used to help organizations in making their financial statements among other things, they are viewed as problematic because most of them have to be derived (Neely, 2007, pg. 98). An analysis done with regards to the International accounting Standard Board shows that the use of fair measurement base in financial accounting is likely to increase. The increase of using the fair value as a measurement best will help in the transformation of the way assets including intangible assets and liabilities are measured. Importance of measurement in accounting Financial accounting measurements are recorded at historical or adjusted cost to the market values through adjusting entries. Management accounting uses measurements to help in calculating the number of labour hours needed or the cost of materials used to produce goods and services. When determining management accounting measurements accountants use special cost allocation methods such as standard costing, job process costing or Activity-based costing. There is no specific method that is used by accountants as the measurements depend on the entity and how they conduct their business. Therefore, accountants determine the best accounting measurement method by identifying and reviewing each production procedure and breaking down the procedures into allocation drivers. Measurement accounting is a continuous or never ending process make it relevant in accounting for its users because each day there are new standards that are set by the ISAFB and FASB. Additionally, it is an evolutionary process because different bodies use different practices in the world for their external financial reporting. By so doing, they use different approaches to measurements in that, different jurisdictions have developed their financial reporting requirements that are influenced by the differences in the uses made for financial reporting information found in regulation and business environments. Measurement accounts evolve even within one jurisdiction because different approaches are adopted by different entities in order to reflect variation in ownership, size and governance. Additionally, businesses hold different types of assets, or liabilities or undertake different types of transactions in the effort of developing practices that reflect the experiences and needs of a specific business. Measurements in financial accounting have been identified to be crucial, but in theory they are the least developed. In that, there is no degree of guidance that is provided to help developers and users of financial accounting. There is great diversity in measurement practices in accounting because of the different measurement bases that have been provided by the International Accounting Standards Board and the Financial Statement of Business Enterprises. Therefore, measurement in financial reporting are connected directly with the idea of recognition of financial statements. Where recognition in this context means the process of formally incorporating an item into financial statements. The recognition of the item is identified in both words and numbers; hence, making the recognition process produce measurements. Under IASB and FASB the recognition criteria require that the elements of financial statements have to be recognized if its cost or value can be measured with sufficient reliability. This means that an entity cannot recognize an element of financial statement unless a reliable value has been assigned to it. However, in most cases the preparers or developers of financial statement find difficulty in arriving at the accurate amount to be recognized, and they opt to use reasonable, estimates in arriving at an approximate value. It is important to understand that the use of estimates is vital in the preparation of financial statements, as long as they do not involve a high degree of uncertainty and subjectivity. Additionally, the estimates should not undermine the reliability of financial information. Current accounting practices Current accounting practices according to Professor Injiri’s have shown an alternative too many diverse quantification rules that are expected to be critically examined (Ijiri, 1978. Pg. 45). The examination might clarify the nature of measurements and can help people discriminated between measurements and other forms of quantification; hence, expounding the nature of measurement in accounting. Current measurement practices are diverse complex and inconsistent because there is a case of something that is presumably consistent and trust. According to the chairman of the IASB Sir David Tweedie, the real aim is to have one single set of accounting standards in that it does not matter whether a transaction takes place in Boston, China or Brisbane all organizations account for their measurements in the same way. There is a growing controversy on the question of measurements in financial accounting. However, the questions have not generated the interests they deserve because many are affected within the accountancy profession and the wider business community. In the ISAB and FASB report in 2005, agreed to tackle initial and subsequent measurement as Phase C during their eight-phase project where they prepared a common conceptual framework. The purpose of the report was to help in improving the understanding of how different financial reporting measurement bases work, their relevance, and reliability and to promote and shape the debate. The second purpose is to identify points that are in arguments for and against each basis of measurement that can be examined and tested in order to help an impartial observer on the view of merits of different bases. The challenge of which way to choose between competing bases for the particular measurement is in some ways difficult than understanding how the bases work as well as the arguments for and against them. The third purpose of the report was to set out proposals for the standard-setters may make decisions on reporting measurements. Different measurement systems There are different measurement systems that give rise to problems in measurement. The most common basis of financial reporting is the Historical cost that is defined as the aggregate price paid by a firm in order to acquire ownership and use of an asset. There is the inclusion of all payments necessary to obtain the asset in the condition, and location required for it to provide services in the production or other operators of the firm. Historical cost was developed for the use in situations where prices change slowly, or they are stable and does not make any provisions for changes in the purchasing power. There are various advantages to historical cost, and they include relevance in making economic decisions. According to Injiri historical cost, affects the selection and evaluation of decision rules because managers determine which decision rules to use quality information of their past decisions. Secondly, historical cost is less subject to manipulation because it is based on actual cost and not merely possible transactions. Lastly, historical cost is useful for control purposes and survives the test of time. Fair value accounting is another example of measurements base which is used for financial accounting. Fair value accounting is also referred to as mark-to-market accounting that is an accepted principle. When companies use fair value accounting in their financial reporting, they measure and report specific assets and liabilities based on their actual or estimated fair market process. There are several advantages to these systems of measurement, and they include accurate valuation and true income. The disadvantages include market effects and value reversal. Thirdly, current cost accounting reflects on the prices that must be paid for an asset or its use at the actual date of the balance sheet or the use or sale if the asset is not already owned. Current accounting is relevant for decision-making purposes because the market value of current costs accounting presents the economic reality or transactions tending to provide more useful and relevant information (Wilks & Burke, 2006. Pg. 120). Additionally, it provides a better measure of efficiency; however, there are various disadvantages associated to this bases of measurement including the openness to subjectivity that current cost provides because it is not based on actual transactions. Current accounting is only relevant when it comes to short-term decision making. Fourthly, there is reliable value and value in use that are used as the basis of measurement in accounting. Bases of measurement in financial reporting are not permanent in the sense that they are not crave in stone. Because different people have different views on how each basis works and their meaning as the practice changes each day. The question of recognition should also be considered because they are different and separate in practice and theory. For example, in practice different measurements bases lead to the recognition of different liabilities and assets. The measurement will be accurate within a certain degree of probability or a certain range, and to describe it as merely reliable or unreliable is simple in measurement accounting. Problems caused by different measurement systems Financial reporting measurements affect everyone directly or indirectly because they help in determining the allocation of capital across economic sectors, countries and companies as well as within individual businesses. There is a growing controversy that surrounds the question of measurement because it is perceived that people or moving away from the traditional measurements basis to a new basis that is the fair value measurements. For that reason, many problems have emerged in relation to measurement in accounts. First, there are inconsistencies in the measurement practices, which has led to new ways of doing business as well as the emergence of different types or methods in the number theory or what is commonly referred to as the additive problem. There has been the introduction of new reporting practices to help in coping with the evolutionary world of business that requires items to be recorded at a fair or current value as a substitute for the Historical cost. The reason for the change is that businesses have evolved, so much that there is a wide range of entities that create long term liabilities, which do not have a definite, cost at the time they are incurred. For that reason, it is difficult to determine how historical cost of the indeterminate liabilities for the future amount to and because the accounts are necessary to reflect expectation a room is created to find new ways to carry out the estimates. Secondly, there are disparities between historical cost, and current cost in that there is a huge difference between assets historical cost and their current value. Because questions always arise to whether the historical cost of property bought about 25 years ago but is now worth more than its historical cost is more information to give out than its current value. This has led to the development of practices allow revaluation of certain assets in order to deal with disparities in opposite directions. Thirdly, the measurement bases have brought a method that to manipulate historical cost results in that historical cost measurements, can be manipulated top produce figures that are regarded as misleading. Hence, there is a need to develop practices that allow regular re-evaluations to be conducted. The reasons the problems exist and why it is hard to solve them The causes or the reason the problem arise from evolution of measurement practices are hard to determine because they do not fall into one chronological order and are sometimes not logical. Problems exist because there is an option for change in that if the entities were not provided with different measurement methods they would stick with the historical cost (Chapman, Hopwood & Shields, 2009. Pg. 79). However, because of the evolution of measurement in accounting they have to option to change and to choose, which method to use that suit their work framework. Additionally, although entities are provided with the option for change, there is also the element of inconsistency that is involved in the different measurement methods. It has been established by the accounting bodies that the existing practices are diverse, complex and inconsistent. Entities try to find measurement practices that are secure, uniform and consistent. In deciding whether there will be more changes in the future to choices are given on diversity and consistency of bases of measurements in financial accounting and they are whether there is a need for consistency for different items with in an entity’s account, and whether there is need for consistency across different types of entities. Secondly, the financial reporting measurement is problematic because the results of the financial reports are affected by the purpose of the measurement. Secondly, there is the double-entry book-keeping that can mean that sensible measures of one item in accounts leads to less sensible measurement of another. Even though, clarity and agreement were found on these two matters financial reporting measurements would face problems because they attempt to capture a continuous process of business at a specific moment, or between moments in time. Additionally, problems exist because when it comes to determining what separable assets are to be measured. Because businesses are created to bring together diverse resources, as well as develop synergies that are only realized when jointly produced in cash flows. Therefore, separating them becomes a problem because business entities acquire property separately, but realize benefits jointly. Problem exists because it is hard to predict how incomplete business will turn out, as well as how to allocate values to different separable assets. In addition, to the above reason why problems exist in financial reporting measurement there is different past and future accounting period and, therefore, identifying market and other sources of values to be incorporate into the measure of incompletes business activities becomes impossible. Conclusion In conclusion, financial reporting measurement are vital for any organization and realizing the actual method or bases to use is important. However, being that the accounting process is evolutionary it means that things change from one jurisdiction to another. This does not mean that the standard method of calculating financial reports should be given up. On the contrary, the ISAB and FASB should find a standardized method of financial reporting measurement to ensure the standards are equal internationally. Conversely, because there is no standard method entities should ensure that they provide accurate figures to their creditors and investors, as well as shareholders to ensure that their business carries on. Recommendation My recommendation to the standard setters is that although there is no standard financial reporting measurement it does not mean that they should stop there. They should ensure that the measurements used in accounting bring a balance between cost and benefit. They should also be timely in the sense that they should move with the changing times. This is because if they do not find a way to do that entities will find the way to calculate the financial reports and they may not be as accurate as they are supposed to be because they will be for the benefit of the entity. Lastly, corporations and entities should have a clear understanding of the financial reporting measurements to help them in making the relevant decisions in accounting. References Chapman, C. S., Hopwood, A. G., & Shields, M. D. (2009). Handbooks of Management Accounting Research 3-Volume Set. Burlington, Elsevier http://public.eblib.com/choice/publicfullrecord.aspx?p=421049. Ijiri, Y. (1978). The foundations of accounting measurement. Houston, Tex, Scholars Book Co. Neely, A. D. (2007). Business performance measurement: unifying theories and integrating practice. Cambridge, Cambridge University Press. Wilks, C., & Burke, L. (2006). Management accounting: decision management: managerial level. Oxford, CIMA. Read More