ch04 sm rankin

Solution Manual

to accompany

Contemporary Issues in Accounting

Michaela Rankin, Patricia Stanton, Susan McGowan, Kimberly Ferlauto

& Matt Tilling

PREPARED BY:

Kimberly Ferlauto

John Wiley & Sons Australia, Ltd 2012

Solution manual to accompany: Contemporary Issues in Accounting

CHAPTER 4

MEASUREMENT

Contemporary Issue 4.1 The standard setters search for the ‘best’ measurement basis

1. What is meant by the term market context? Why is context so important in accounting measurement? (K)

Measurement methods used in the preparation of the financial statements should be selected with the market context in mind. Values determined without market context in mind may not be reflective of market conditions or meet user’s needs. In other words, to provide the most accurate and decision useful accounting information, the most appropriate measurement approach is likely to be dependent on specific circumstances such as the nature of the market for the asset at the time. If the market is to play a role in valuation, we want to ensure that the resulting value reflects the fundamental value of the asset and that the operation of market forces does not lead to over or under valuation of the asset. What is important to users may also change from time to time.

2. Is adoption of a single measurement base approach likely to work in practice? Justify your response. (J, K)

Responses to this essay style question will vary from student to student. Students should be encouraged to form their own views and provide in depth discussion supported by references and examples. Some key points of relevance include:

Arguments for adoption of a single measurement base approach are based on an idealised view of markets being complete and in perfectly competitive equilibrium. In reality, markets are imperfect and incomplete and ideal unique market prices are not available for all assets and liabilities. This has led to the use of the fair value hierarchy. The lower levels of the hierarchy requiring estimation of what the market price might be if one existed. The information produced is therefore not ideal.

A single preselected measurement method may not best reflect market conditions or meet user needs at that time.

Assumes a particular measure will always be the most relevant and will always be able to be reliably measured.

Some argue that there is no single ideal measure and that the focus should be on identifying the information that is most likely to meet the needs of user’s decision models.

Application of IAS 39 during the recent GFC as an illustration of the practical importance of market imperfection and incompleteness.

© John Wiley and Sons Australia, Ltd 2012 4.1

Chapter 4: Measurement

3. Why do you think standard setters have considered a single measurement base

approach? In your response, consider the fundamental problems that such an approach could help resolve and how such an approach would fit with the qualitative characteristics of accounting information prescribed under the Conceptual Framework. (K, CT)

Responses to this essay style question will vary from student to student. Students should be encouraged to form their own views and provide in depth discussion supported by references and examples. Some key points of relevance include:

In perfect market conditions, there is a unique market price based on full information for every asset and liability. This provides a relevant, reliable and objective measure of an assets fair value when such observable market prices are available. This argument seems to be a key driver behind the push for fair value as the single ideal measurement base approach.

Mixing different measurement bases is believed to create mismatch problems. This problem refers to the fact that different items in the same set of accounts are measured on a different basis, making aggregation (totals) misleading. A single measurement base approach would promote consistency within accounts, avoiding this mismatch, and allowing more meaningful aggregation. This approach would also improve comparability of accounts between different entities.

Fair value favoured approach due to its relevance – measures market expectations of future cash flows to be derived by the entity and objectivity – reflecting the markets view rather than views of management associated with the entity.

Contemporary Issue 4.2 The subprime lending crisis and reliable reporting

1. In practice, which measurement base, historical cost or fair value, would provide the most relevant and reliable accounting information? Draw on the facts presented in the situation above, as well as your knowledge of the global financial crisis, to justify your response. (J, K)

Responses may vary from student to student as there are many paths that discussion could take. Some key discussion points follow.

Fair value or historical cost on their own are not likely to achieve both characteristics. Inherent trade-off between relevance and reliability – the information which is most

relevant is often less reliable. The information which is most reliable tends to be that which is less relevant.

There has been a move towards fair value and away from historical cost on the basis of relevance. It is argued that reporting assets and liabilities at their fair values provides more relevant information for investment decisions than historical cost.



Reliability is difficult to achieve under fair value when we are dealing with hypothetical transactions that are not objectively measureable. This is the situation we face when observable market prices are not available. In other words, when an active and liquid market does not exist for the asset. Some argue that once reliability becomes compromised, the information produced also becomes less relevant.

Integration of the two measurement bases suggested. For example, historical cost financial reports could be enhanced by providing fair value information through footnote disclosures. A balance to achieve both greater relevance and reliability.

2. Discuss the role of market stability and the financial business cycle in determining the relevance and reliability of the accounting information produced. (J, K)

Market stability and the nature of the financial business cycle play a large role in the determination of market prices, and therefore impact upon the relevance and reliability of accounting information produced using fair value.

Falling prices in an unstable market may worsen market stability. Companies tend to react to falling prices by rushing out to sell their assets before their competitors, causing a further downward spiral in prices.

In a market bubble, values may be overstated, and values will most likely not be realisable if many market participants decide to sell those assets at the same time. The bubble bursts and prices fall again.

Financial statements measuring assets and liabilities at fair value in unstable or illiquid markets are not likely to be relevant or reliable for the purpose of decision usefulness.

Students may refer to the subprime lending crisis or other examples to illustrate the role of market stability and the financial business cycle.

Contemporary Issue 4.3 Current debates on accounting for financial instruments: perspectives in the aftermath of a crisis

1. ‘The market is far too complex to be captured by an accounting system.’ Discuss this statement, providing evidence from the global financial crisis. (J, K, SM)

Responses to this essay style question may vary from student to student. Some points of relevance include:

It seems appropriate that under normal circumstances, assets should be valued at what they are worth from the markets point of view, the market being the only valid standard of value. We are comfortable with this concept when markets are



functioning normally. However, we do not know what to do when the market does not function normally.

The financial crisis has played a role in highlighting issues and bringing light to debates concerning the concept of fair value. Recent events have made us more aware of the complexity of the market and the associated issues that may arise when we choose to use market prices as an indicator of fair value.

Concerns regarding operation of financial markets and whether market values/prices are really reflective of the fundamental value of assets.

The important thing here is that students are able to identify a few key arguments and discuss them in depth, providing specific examples to support and justify their views.

2. Analyse the players involved in the recent debate surrounding fair value and its

contribution to the global financial crisis. Discuss how this demonstrates the political nature of accounting measurement. (J, K, SM)

Responses to this question will vary from student to student. There were many players involved. Students should be encouraged to focus on two or three and analyse them in depth. Key players include accountants, regulators, management, banks, investors, just to name a few. Encourage students to read widely the literature surrounding fair value and its contribution to the global financial crisis. The amount of literature contributing to this debate is amazing.

Students also need to be able to develop clear links to demonstrate the political nature of accounting measurement.

T

Review Questions



1. Define measurement in the context of accounting and financial reporting.

The Conceptual Framework defines measurement as:

The process of determining the monetary amounts at which the elements of the financial statements are to be recognised and carried in the balance sheet and income statement

Measurement in an accounting context therefore refers to the way the figures on the financial statements are determined. It is described as an act or process which may involve calculations, making estimates and comparisons, and apportioning or distributing amounts.

2. Why is measurement so important in accounting?

Measurement is crucial to be able to provide decision-useful accounting information and to accurately appraise the performance of management. These are the primary purposes for which financial statements are prepared.

The way items are measured in accounting impacts on the quality of accounting information produced. In order to fulfil the decision-usefulness objective, the financial statements produced must contain good quality accounting information which will assist decision makers in making the right (appropriate) decisions. Poor quality accounting information, resulting from the use of inappropriate measurement methods, may mislead users and this could potentially cause them to make wrong (inappropriate) decisions. If accounting information leads to wrong or inappropriate decisions it is not useful.

The financial statements produced must also contain good quality accounting information in order to accurately determine how well management has performed its role in managing the resources of the entity. Poor quality accounting information, resulting from the use of inappropriate measurement methods, will give the wrong impression as to how well management has performed its role.

3. Discuss the current approach to measurement adopted by standard setters. Why

have they adopted such an approach? What are the issues and problems associated with this approach?

Under the international standards we adopt what we call a mixed measurement model. Under this approach a number of different measurement bases are employed in the preparation of the financial statements. Historical cost, current cost, realisable value and present value are all employed to different degrees and in varying combinations during the preparation of the financial statements.

The main reason for adopting such an approach is the need for flexibility. This model allows for use of a number of different measurement bases. This is necessary due to the differences in the substance or nature of transactions between entities and also due to the differing circumstances that entities can find themselves in.



Issues and problems associated with this approach include:

Variations in accounting practice – entities may choose to account for the same or similar items in different ways using different measurement methods. How they measure and account for an item may be appropriate for the individual entity but could reduce comparability across entities.

Potential for different financial results being reported when different measurement methods are allowed and used.

Discretion means opportunity for management to make opportunistic accounting choices, creating a biased picture of reality and perhaps even misleading users.

In summary, the approach is necessary but subjective in nature. This highlights the importance of professional judgement and ethics in accounting.

4. Explain the arguments for and against using historical cost as a measurement base.

Key arguments for historical cost include:

Most objective measurement approach - amounts are determined based on actual transactions.

Clear audit trail – amounts can usually be proven by documentation.

Key arguments against historical cost include:

Amounts determined may not be relevant to current decision making if there is a long time span since the transaction occurred. Historical cost does not take into account changes in the value of money over time. In other words, it ignores price inflation.

The amount paid for an item or received for an item may not necessarily be indicative of its value.

Judgement involved in determining depreciation rates can create inconsistencies and opportunity for manipulation.

Inability to determine the cost of some items. Items may be donated with no actual cost to the entity. Items may be internally generated rather than purchased.

5. Explain the difference between current and replacement costs.

Current costs and replacement costs are both essentially the costs that would be incurred if we were to replace the items now. However, these terms represent two different methods of measuring the cost of replacing the items. Current cost requires the item be valued and recorded at the amount that would be paid at the current time to provide the future economic benefits expected to be derived from the current item. Replacement cost requires the item to be valued and recorded at the amount that would be paid at the current time to purchase an identical item.



Current cost is a broader concept in that it represents the cost of obtaining the same expected future economic benefits, but these benefits may be assumed to be achieved in different ways, not necessarily through purchase of an identical item. Replacement cost is much more specific in that it represents the cost of purchasing another item identical to the current one.

6. Explain the arguments for and against using fair value as a measurement base.

Key arguments for fair value include:

Most relevant measurement approach for current decision making. The amount that will be received for an item or that will need to be paid for an item is decision useful information.

Objective if determined by reference to the market price for an item. The market price is set by forces outside the entity. It is not biased by judgement and cannot be manipulated or influenced by management.

Key arguments against fair value include:

Subjective where a market price is unavailable. Some items are not regularly traded in an active market and an estimate of the items fair value must be made.

The focus on exit values is not logical and contradicts the going concern assumption. We are measuring as though we are going to sell off all the assets which is not usually the case.

Market prices can be volatile and therefore sometimes may not be indicative of the true value of an item. Short term fluctuations in fair value may be irrelevant and cause confusion from a user perspective.

7. What role does estimation and judgement play in accounting measurement? Discuss with particular reference to present value and deprival value.

The key issue to note here is that certain measurement methods are more subjective than others. As a consequence, the relevance, usefulness and reliability of the accounting information produced using these more subjective measurement methods becomes questionable.

Present value is a good example because managements estimations of cash flows expected to be received in the future can be quite subjective. The estimations are made at management’s discretion and their internal biases may come into play. Assertions and assumptions are made by management in forming such estimates, and for this reason, the values determined cannot be assumed to be objective. Present value is also subjective in the sense that there are also a wide range of discount rates to choose from. There is often much variation between entities in the discount rates applied.



Deprival value is also quite a subjective measurement method for similar reasons. There are a range of ways in which deprival value may be determined, depending upon the assumptions and decisions made by management.

8. Identify factors that may influence the choice of measurement approach. Discuss how

the measurement approach adopted impacts on the quality of accounting information produced.

Key influences include:

Potential users of the financial statements - user needs must be understood in order to choose the measurement approach which will provide the most decision useful information.

Practical considerations – a particular cost or value may be too difficult or even impossible to determine. Choice of measurement approach also needs to be cost effective. The cost of obtaining or calculating the cost or value must be considered.

Management’s motivations and objectives – motivations, underlying objectives and time horizon can all influence management behaviour in terms of choice of measurement approach. For example, if management have a short term focus, are on a shorter term employment contract, or have bonuses tied to profits, they will most likely choose the measurement approach which produces the best results in terms of higher profits.

The measurement approach adopted impacts on the quality of accounting information because it has a direct impact on the relevance, faithful representation, understandability, comparability and verifiability of the information produced. Accounting information which possesses these characteristics is more decision useful, therefore fulfilling the decision usefulness objective, the purpose for which financial statements are prepared.

A detailed analysis of how each of the individual measurement approaches discussed in the text impacts on the quality of accounting information can be found on pages 104-107.

9. Why has measurement become such a controversial accounting issue in recent times?

In recent years there has been a significant paradigm shift in relation to accounting measurement. There has been a distinct move away from historical cost toward fair value and fair value is by far the most controversial measurement approach. Key reasons for such controversy include:

Subjective nature of estimates involved in determining fair value where no active market exists for an item

Role of management assumptions and judgement make accounting information produced more prone to manipulation

Variability in valuation techniques used between entities



Volatility in earnings reported as a consequence of changes in fair value from period to period

Potentially misleading nature of the earnings figure produced under fair value

Some points regarding the controversial nature of accounting measurement in a more general sense follow:

Potential for inappropriate choices in measurement approach Variability in measurement approaches adopted for the same or similar assets Political influences on measurement decisions Subjectivity and discretion involved in determination of some values Impact of measurement on achievement of other organisational objectives

10. Discuss the political aspects of accounting measurement.

Key points are as follows:

Numerous different interest groups are involved in accounting regulation through the standard setting process. The process incorporates lobbying by the different interest groups with regard to measurement issues embedded within the standards. Interest groups are often biased or influenced by self serving objectives.

Wealth transfers often provide the basis or incentive for decisions made in relation to accounting measurement. Most parties and interest groups within our economy would act to maximise their own wealth, not necessarily with the best interests of stakeholders or the decision usefulness of information produced in mind.

Validity and acceptance of use of fair value as a measurement approach in times of economic downturn. Impacts on wealth within the economy need to be considered in the sense that certain types of entities may be disadvantaged by the decision to adopt fair value. The nature of an entities asset base and the transactions they undertake may mean they are more vulnerable to economic downturn and the operation of the capital market, causing them to report greater losses.

Use of fair value has also revealed the truth in some circumstances, highlighting losses that were masked by different accounting treatment adopted previously. This has brought financial reporting into the public eye and made it a public concern.

Reliability of accounting information produced using fair value as the measurement base. Where no active market exists for an item, determination of fair value becomes quite subjective. With discretion and judgement comes opportunity for potential manipulation of values. This issue has been highlighted in recent corporate collapses where the complex interactions of individuals within society and consideration of what motivates them to make particular accounting choices and decisions has come under great public scrutiny.

Accounting has been the scapegoat for many circumstances which have had far reaching impacts on the public. Views put forward in the literature have been inconsistent in that they are largely dependent on what issues are currently prevalent



in the political arena. Players seem to change their view and opinion of the appropriateness of the various measurement approaches depending upon current political objectives and what needs to be achieved. In this sense, we can view accounting measurement as a political tool.

Difficult nature of managing the political relationships that arise due to stakeholders conflicting interests. For example, the conflict that arose between regulators and banks in the context of the recent GFC.

Inadequate operation of financial markets, resulting in prices which are not necessarily indicative of market value. For example, during the GFC agency ratings were a key information source and therefore played a major role in the markets determination of price. The fact that the ratings agencies were paid by the entities means ratings given were not necessarily reflective of true risk and the whole market mechanism fell apart. In situations such as this, we even begin to question the accuracy of market prices and the whole market mechanism which we have come to rely on comes under scrutiny.

11. In your own words, explain what different stakeholders want from financial statements. Assess the impact of measurement on the extent to which accountants are able to fulfil stakeholder needs.

Different stakeholders all want something different from the financial statements. These differing needs must be considered and balanced out in the preparation of the financial statements.

Existing and potential investors are concerned about two key things. The risk they are exposing themselves to and the return they can expect from their investment in the entity. They want accounting information that will assist them in deciding whether to buy, hold, or sell their shares in the entity. They also want accounting information which will help them to assess the entities ability to pay dividends. In other words, they are interested in the potential value and future viability of the entity, with a particular interest in current values and the entities ability to generate profits.

Lenders and other creditors want accounting information that will enable them to determine whether amounts owing to them will be paid when due. They are therefore most interested in the entities net position, the amount of liabilities it has compared to the assets it holds. They want information that reflects the current value of assets and liabilities, giving an indication of the future viability of the entity.

There is a need for adoption of different measurement approaches in order to satisfy the needs of key stakeholders. In fact, even an individual stakeholder demonstrates a need for accounting information based on more than one measurement approach. It is evident that what is an appropriate measurement approach needs to be considered in context and is very much dependent upon the entity, its objectives and current circumstances. This reinforces the need for a mixed measurement model in order to satisfy stakeholder needs.



Application Questions

4.1 Obtain the annual reports of three companies in the same industry and consider the items included in property, plant and equipment. Answer the following questions. (J, K, SM)



(a) What range of measures is used to determine amounts for these items in the reports of the individual companies? Do you think it is valid to add the items, given the measures used? How would you interpret the total amount for property, plant and equipment in the financial statements?

The range of measures used will vary depending upon the annual reports selected by the students. Students should however be able to describe succinctly the approach/approaches taken in measuring the company’s property, plant and equipment. If there is a wide range of measures used it may also be useful for students to think about and comment on why this is necessary.

Adding items determined using different measurement approaches gives rise to the additivity problem. It is not really logical to derive meaning from the total figure when a range of different measures are used. Even if the same measurement approach was used to determine the amounts for all property, plant and equipment items, the fact that the amounts were most likely determined at different points in time, makes the total less meaningful.

(b) Compare the measures used by the different companies for similar items. Are there any inconsistencies in how similar items are measured by the different companies?

Responses will obviously vary depending upon the combination of reports selected by students. It is important to get students to tease out why any identified inconsistencies have occurred and develop their thoughts as to whether such inconsistency is justified.

4.2 Examine the requirements for measuring financial instruments in AASB 139/IAS 39 Financial Instruments: Recognition and Measurement. What measures are used to determine amounts for these items? (J, K)

Students are required to examine AASB 139/IAS 39 and describe the measures required to be used for the different categories of financial instruments.

Do you think it is necessary to use different measurement bases for different types of financial instruments? Justify your response.

Encourage students to form their own view by exploring the nature of each of the different categories of financial instruments and thinking about how they differ from one and other. It is also important that students analyse the appropriateness of the measurement approach required for each category and determine whether there is justification for different measurement bases. The nature and characteristics of the different categories of financial instruments should come into the discussion here.

4.3 Examine the requirements for measuring assets at fair value in AASB 138/IAS 38 Intangible Assets. (J, K, AS)



(a) How can fair value be determined under this standard?

Students are required to refer to AASB 138/IAS 38 and describe how fair value may be determined under this standard.

(b) What impact would the differences in the methods allowed to determine fair value have on the financial reports? In particular, consider the potential impact on reported profits.

Students should be encouraged to explore this issue in depth, thinking about the specific impacts of each method on the financial report and then exploring the impact on reported profits in further depth. Some methods have a greater impact on reported profits than others and students should be encouraged to take their discussion further by thinking about the consequences of or motivations behind using a particular method to determine fair value.

4.4 Examine the requirements for measuring assets at fair value in AASB 141/IAS 41 Agriculture. (J, K, AS)

(a) How can fair value be determined under this standard?

Students are required to refer to AASB 141/IAS 41 and describe how fair value may be determined under this standard.

(b) What impact would the differences in the methods allowed to determine fair value have on the financial reports? In particular, consider the potential impact on reported profits.

Students should be encouraged to explore this issue in depth, thinking about the specific impacts of each method on the financial report and then exploring the impact on reported profits in further depth. Some methods have a greater impact on reported profits than others and students should be encouraged to take their discussion further by thinking about the consequences of or motivations behind using a particular method to determine fair value.

4.5 Do you think the requirement for an active market should be mandatory when measuring at fair value? What problems can occur when determining fair value of an item in the absence of an active and liquid market? Provide examples to justify your response. (J, K)

Responses to this question will vary from student to student. Students may go either way but a good response will acknowledge arguments for and against. Some key points of relevance are outlined below.

Many argue that measurement at fair value can only be reliable and accurate when determined using market prices derived from an active and liquid market.



Reference to market prices is certainly the most objective way of determining fair value but do the prices accurately reflect the fundamental value of the asset being measured? In other words, can we be sure the market mechanism is operating effectively so as to not over/under price items.

Market price may not be reflective of the fair value of an item which makes the information produced less relevant and useful to users. It is often argued that in some circumstances a calculation using a specific internal model is necessary to accurately estimate fair value.

It is generally argued that determination of fair value in the absence of an active and liquid market is quite subjective. Market prices are determined by the interaction of forces outside the entity while other approaches used to estimate fair value in the absence of an active and liquid market require management to make various assertions and assumptions. Considerable judgment and discretion on the part of management is involved when an active market does not exist for the item.

Accounting information produced may be misleading if management makes inappropriate assumptions or makes other decision which when left to their judgement or discretion are made inappropriately.

Estimations of fair value can become quite complex and confusing from a user perspective. This then impacts on the understandability of information produced.

Students should draw on examples that they are familiar with to justify their response.

4.6 The following information is provided about a particular machine used by a company in its operations. The machine is technological in nature and new models are coming out all the time. The machine originally cost $80 000 and it would cost $140 000 now to replace this machine. The company expects to receive $112 000 (discounted to present value) in cash inflows from using this machine over the next 5 years. If we were to sell it now, the machine would bring in $60 000. Consider the decision usefulness of accounting information produced when using each of the above figures as a measure of the value of the machine. In particular, consider usefulness from the perspective of the following stakeholders:

(a) Shareholders(b) Creditors(c) Employees

Original cost $80 000 – This represents the amount paid for the machine when it was originally purchased. This amount is not necessarily very decision useful from a user perspective, especially if the machine was purchased a long time ago. Users are not really interested in how much was paid for an item in the past.

Cost $140 000 to replace the machine now – This represents the current amount we would have to pay to purchase a machine identical to the one being replaced. This amount is a good indicator of the current value of the machine and is decision useful from a user perspective.



However, if the machine is technological in nature and new models are coming out all the time, this method of measuring the value of the machine does not make sense. The current machine would most likely not be replaced with an identical one. It would be replaced with a better and more efficient model. In which case, the current cost of an identical machine is irrelevant. The cost of reaping the same benefits using a new and better machine may be quite different to the cost indicated above.

Present value $112 000 – This amount represents the benefits expected to be derived from the machine over the next 5 years in current dollars. This is a good indicator of the value of the machine and is decision useful from a user perspective because it is forward looking and provides information about current value and future viability.

Sell now $60 000 – This amount represents the current market value for this particular item. In other words, the amount we would receive if we were to sell it now. This is a reasonably good indicator of the value of the machine but could also be misleading. For example, if the machine is still very efficient and productive, what it would sell for in the market a few years later is not necessarily going to reflective of its value. In other words, we can argue that use of this approach would lead to the machine being undervalued. The other side of the argument is that this particular model may not even sell, given the technological nature of the machine and the fact that there are new and better models on the market. One could also argue that use of this approach would lead to the machine being overvalued. Decision usefulness of the information produced using this approach to value the machine is therefore questionable.

Shareholders are interested in the current value of their investment and the ability of the entity to pay dividends in the future. Therefore present value as an indicator of the value of the machine would be most useful from their perspective.

Creditors are interested in the entities ability to pay its debts when they become due. They are interested in the entities current value and in particular it’s net position. The original cost of the machine would therefore be irrelevant from their perspective. Depending upon the particular circumstances of the machine, replacement cost, present value or even the sale value would provide information which is useful from a creditor perspective. The approach that will provide the most decision useful information depends on management’s intent with regard to the asset and how long it has been held.

Employees are interested primarily in the future viability of the entity, particularly their ability to pay their wages in the future. Therefore present value as an indicator of the value of the machine would be most useful from their perspective.

4.7 Obtain the annual reports of two companies in different industries. Assess the decision usefulness of the accounting information contained within these reports from the perspective of the following stakeholders. In your response include an



explanation of how the measurement approaches adopted have impacted on the usefulness of the information. (J, K, SM)

(a) Shareholders(b) Managers(c) Government

Student responses to this question will vary according to the entities selected. Discussion points raised will depend on the measurement approaches adopted by the entity and the nature of who the key stakeholders are.

The most important thing is that students are able to develop clear links and adequately explain these linkages between the measurement approaches adopted and the decision usefulness of accounting information. Students should be able to identify and analyse such linkages in some depth.

It is also important for students to note that the extent of the decision usefulness of accounting information is very much dependent upon who the key stakeholders are. For example, shareholders are most interested in information which reflects the current value of the entity, its future viability and ability to generate profits, while managers are more interested in information about the internal operation of the entity and its efficiency that will help them to make important decisions. Government is most interested in information which tells them about whether the entity has complied with particular rules and regulations. Information about the general financial well being of the entity may also be useful from a government perspective, depending upon the relationship that exists between the entity and the government.

4.8 Obtain the annual reports of two companies in the forestry industry (usually available from company websites) and consider the items included in biological assets. Answer the following questions. (J, K, SM)

(a) What range of measures is used to determine amounts for these items in the reports of the individual companies? Do you think it is valid to add the items, given the measures used? How would you interpret the total amount for biological assets in the financial statements?

The range of measures used will vary depending upon the annual reports selected by the students and the nature of the biological assets held by the entity. Students should however be able to describe succinctly the approach/approaches taken in measuring the company’s biological assets. If there is a wide range of measures used it may also be useful for students to think about and comment on why this is necessary.

Adding items determined using different measurement approaches gives rise to the additivity problem. It is not really logical to derive meaning from the total figure when a range of different measures are used. Even if the same measurement approach was used to determine



the amounts for all biological assets, the fact that the amounts were most likely determined at different points in time, makes the total less meaningful.

(b) Compare the measures used by the different companies for similar items. Are there any inconsistencies in how similar items are measured by the different companies?

Responses will obviously vary depending upon the combination of reports selected by students. It is important to get students to tease out why any identified inconsistencies have occurred and develop their thoughts as to whether such inconsistency is justified.

4.9 Find a current discussion paper or proposal on the IASB website. Discuss the measurement issues raised in the paper and examine the importance of resolving these issues from a standard-setting perspective. (J, K, SM)

Responses to this question will vary depending upon what is on the IASB’s agenda at the time. It is important that students are able to identify and summarise the measurement issues raised in their selected paper, extending their discussion to incorporate analysis of the consequences of issues raised and explain why resolution is important.

4.10 Find the comment letters received on a current proposal or discussion paper on the IASB website and answer the following questions. (J, K, SM)

(a) Have any of the comment letters referred to measurement issues?

Responses to this question will vary according to the proposal or discussion paper selected by the student. The nature and extent of the discussion will depend upon what is out for comment at the time.

(b) Identify the key stakeholder groups. Establish whether there is agreement or disagreement within these groups and between the different groups, as to the appropriate measurement to be used.

Relevant stakeholders should be clearly identified and points of consensus and inconsistency discussed in some depth. It is important that students look for consensus and inconsistencies within each stakeholder group as well as between the different stakeholder groups.

(c) Are there any major concerns in relation to measurement? Do you agree or disagree with the comments made?

It is important that students are able to identify and explain the key concerns in relation to measurement. It is also important that students take a stand as to whether they agree or disagree with these concerns and are able to justify their view. Students might find it interesting to think about and consider the motivations underlying stakeholder concerns.



Case Study Questions

Case Study 4.1 Taking account of water

1. Is it appropriate to place a dollar value on water? Justify your response. (J)



Responses will vary from student to student. The important thing is that students are able to justify their response and provide evidence in the form of references and examples to support their arguments.

Some argue that it is inappropriate to place a dollar value on water. Some argue that it would be very difficult given the seasonal uncertainty of environmental assets and the inconsistent relationship between cost and use across the various seasons.

However, the discussion in this case highlights that this complexity has actually created the need for better seasonal measurement of available water volume. This would allow us to make better decisions regarding the use of available water, promoting greater efficiency and sustainability of water use. Sustainability is the key driver behind the initiatives to place a value on water assets.

2. In the case above, what is actually measured and how is it measured? (K)

What is measured?

volume of water available disaggregated by the individual river systems Contributing to the basin

how much water, in a particular season, should be made available for industrial and urban uses

How is it measured?

It is argued that the value of water is derived though the cost of making it available, reflected by a water planning and management charge which requires water authorities to determine their administrative, planning and management costs in providing water. A user pays approach should be adopted to fully recover these costs and the amount paid by users is therefore representative of the value of water. Hopefully this will highlight the value of water to users, portraying it as a valuable asset rather than a public good, and contributing to sustainability.

3. What are the potential issues associated with measurement of water? (J,K)

Potential issues highlighted in this case include:

Lack of acceptance of a user pays approach. This approach promotes water as a valuable asset, while institutionalised low water usage charges in the past reflect the traditional emphasis on the ‘public good’ nature of water.

Effective pricing has proven to be important because water pollution has been found to be directly attributable to the lack of an effective pricing system.

If water authorities seek to fully recover costs, user charges may become unreasonable. The key industry impacted is agriculture which is one that we would expect to maintain low prices. The approach outlined in the case certainly has potential to adversely impact on agricultural produce prices and local communities.



Will disclosures in relation to the detail of the water authorities water planning and management costs and the methodologies used for calculating them really impact on the decision making of users? To promote greater efficiency and sustainability of water use the requirement for disclosures must focus on information which is critical in terms of relevance to users in sustainability decision making. This is difficult to ascertain and requires further understanding of this decision making process.

Seasonal uncertainty of environmental assets and an inconsistent relationship between cost and use across the various seasons, make information about user charges and how they relate to the costs of activities less meaningful from a user perspective.

Given that measurement of water and the provision of relevant information could become quite a costly process for water entities, can we be sure that governments will respond to the data appropriately and make the tough decisions about reducing allocations where appropriate, so that we are able to achieve that ecologically sensible net surplus and work toward the overall objectives of greater efficiency and sustainability.

4. Discuss whether such information is decision useful from the perspective of various

stakeholders. (J)

Responses will vary from student to student. Students should however provide a fairly in depth analysis of relevant stakeholder needs with a focus on the key issues such as a need for greater efficiency when it comes to water usage and long term sustainability. The main stakeholders include water authorities, water users and government. Students could also take this a step further and break down the different stakeholder groups mentioned above. For example, water users could be broken down into industrial and urban users. Industrial users could then be explored from the perspective of different industries. Students should be encouraged to explore decision usefulness of such information at a general level and then drill down to get as specific as possible when discussing key stakeholders.

5. What can we expect to achieve through accounting for water? Explain the connection to sustainability decision making. (J, K)

The problem highlighted in the case is that in the MDB, the water available is insufficient to meet the demands of all agricultural and urban uses as well as the needs of the environment. It is hoped that accounting for water will lead to greater efficiency with regard to water usage and longer term sustainability. The logic being that if we can highlight its value to users and decision makers by allocating a monetary value, it will be portrayed and treated as a valuable asset moving forward.

Case Study 4.2 CMG Worldwide: intangible assets

1. What is an intangible asset? Describe the nature of intangible assets that might be associated with celebrity personalities. (K)



An intangible asset is essentially something of value which we cannot physically see or touch. For example, the reputation associated with a brand name, the goodwill associated with a business.

The nature of intangible assets that might be associated with celebrity personalities may include intellectual property rights. In this case, CMG worldwide is a licensing agency which works to manage, market and protect the valuable intellectual property of celebrity personalities. Something else which is also of great value is the goodwill associated with their name and with them as a person. It is important that this valuable asset be protected and managed.

2. Explain how we might measure such assets under AASB 138/IAS 38 Intangible Assets. (K, AS)

Responses may vary from student to student. It is important that students explore the issue of measurement of these assets in their own way. It is important that students explore the issues in some depth, incorporating application of IAS 38 into their response. Points of relevance to guide discussion include:

Were the assets internally generated or acquired by the entity? These assets are of a nature that value is created internally by the entity. Students should explain their response in some depth. They should also be able to explain why this distinction is important. The key point being that it impacts on how the intangible asset will be recognised initially.

How should the assets be measured upon initial recognition? Refer to table 4.2, pg 119.

After initial recognition, should the cost model or the revaluation model be used to measure the asset? Students should provide some in depth analysis here in relation to the nature of the asset and each of the two models. Students should be encouraged to explore ideas thinking about what makes sense and what would be most indicative of the value of the asset. Relevance, accuracy and reliability from a user perspective should also be considered.

3. What are the practical difficulties in measuring an asset of this kind? (J, K)

Practical difficulties include:

Intangible assets lack physical substance and are not usually something that can be bought and sold in an active market. This makes measurement at fair value very difficult.

Intangible assets such as these are often unique in nature. There are no readily observable market prices available for the same or similar assets. This also makes measurement at fair value very difficult.



There may be little reliable information available regarding costs of developing the asset.

Ability to generate revenue may be considered to be most indicative of the value of the asset. The issue with this approach is that the estimates made reflect management’s own assumptions and biases, making it less reliable.

In summary, determining an accurate and reliable measurement presents a challenge. The nature of an intangible asset does not really fit or work with the concept of fair value and depending on the nature of the asset and how it is developed or generated, associated costs and relevant expenditure may be difficult to determine.


ch04 sm rankin

Economy & Finance