There are specific problems that affect the different bases of measurement available to financial reporting: historical cost, value to the business, fair value, realisable value and value in use. How the different bases work will be considered separately, but it will be helpful to look first at some issues that generally beset financial reporting measurement.
When applied to financial reporting the term measurement can give a misleading impression of certainty and objectivity. In daily life, measurements are typically made of the physical characteristics of physical objects – such as height, weight, temperature and so on. If accurate measurement tools are employed, information of this sort is objective and uncontroversial. The subjects of measurement in financial reporting, however, are abstract concepts of uncertain meaning such as income and net assets. For this reason alone, their measurement is always liable to be controversial.
All measurements in financial reporting are expressed in monetary terms and therefore purport to be measurements of value. However, value can mean different things. A particular asset might be valued at, for example, its historical cost, its replacement cost or its market value. It cannot be said that any one of these measurements is the one and only correct value for the asset. Each value, if the measurement is made properly, will be correct on the basis being used. In their conceptual frameworks, the financial reporting standard-setters refer to the different attributes of assets and liabilities, which give different values when measured. Historical cost, replacement cost and market value are all attributes in this sense.
The diversity of the purposes for which financial reporting information is used means that a basis of measurement appropriate for one purpose may not be appropriate for all other purposes. If you ask someone the question, ‘What is this company’s income?’, the reply ‘Why do you want to know?’ may be a sensible first step towards providing a useful answer. There is no single, right answer to the question.
These considerations are of particular importance because of an additional characteristic of financial reporting measurement which is a consequence of double-entry bookkeeping. It is impossible to measure one thing (such as an asset, liability, income or expense) without measuring something else (the other side of the bookkeeping entry) at the same time. Sometimes this feature of double-entry can lead to unfortunate results. For example, attempts to produce a sensible measure of income can lead to asset or liability measurements that do not seem to make sense, or vice versa.
Financial reporting measurement is therefore problematical because:
- the results are affected by the purpose of measurement; and Challenges in financial reporting
- double-entry bookkeeping can mean that sensible measures of one item in the accounts lead to less sensible measurements of another.
However, even if clarity and agreement were possible on these inherently subjective matters, financial reporting measurement would still face difficulties because it attempts to capture a continuous process of business activity at a particular moment in time (in the balance sheet) or between two moments in time (in the profit and loss account or income statement). At any moment, a business will be in the middle of a number of incomplete activities. It may, for example, have:
- services in the course of being provided to customers;
- raw materials that have not yet been turned into work-in-progress, work-in-progress that has not yet been turned into finished goods and finished goods that have not yet been sold;
- debtors that have not yet been turned into cash;
- liabilities that have still to crystallise;
- financial instruments that have not matured;
- research, development and exploration activity whose results are still uncertain;
- fixed assets whose useful lives are still in progress;and so on. Capturing these incomplete processes at a particular moment, or between two particular moments, and expressing them in monetary terms, is inevitably a somewhat arbitrary process. How it is done is a matter of judgement and convention and involves grappling with four fundamental problems. These are the problems of: Challenges in financial reporting
- determining what separable assets are to be measured; Challenges in financial reporting
- predicting how incomplete business activities will turn out; Challenges in financial reporting
- allocating values to different separable assets and different past and future accounting periods; and
- identifying markets and other sources of values that can be incorporated into the measurement of incomplete business activities.
More details on the challenges in IFRS financial reporting are made in the following items: