Gregorius Achilles Gunawan

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Weekly Summary Financial Accounting Theory – Week 4
Importance of Measurement

In accounting we measure profit by first assigning a value to capital  calculating profit as the change in capital over the
period

Scales  shows what information the numbers represent

- Nominal scale: numbers used only as labels and represent classification

- Ordinal scale: rank orders objects with respect to a given property & interval between numbers aren’t necessarily
equal
- Interval scale: the distance between each interval is equal & known & an arbitrarily selected zero point exists on the
scale
- Ratio scale: intervals between object are known & equal & a unique origin exists

Permissible Operations of Scales

- Invariance of a scale means that the measurement system will provide the same general form of the variables, and the
decision maker will make the same decisions
- Nominal and ordinal scales  no arithmetic operations
- Interval scale  addition and subtraction
- Ratio scale  all arithmetic operations

Types of Measurement

- Fundamental Measurements: numbers are assigned by reference to natural laws & Fundamental properties are
additive (e.g. length, number and volume)
- Derived Measurements: one that depends on the measurement of two or more other quantities & depends on known
relationships to fundamental properties (e.g. the measurement of profit depends on the measurement of both income
and expenses)
- Fiat Measurements: Typical in social sciences including accounting & based on arbitrary definitions (e.g. of profit)

Reliability and Accuracy

- Sources of errors are (1) measurement operations stated imprecisely, (2) measurer, (3) instrument, (4) environment
attribute unclear, (4) risk and uncertainty  need to establish limits of acceptable error
- Reliable measurement:
a. Definition: proven consistency, repeatable or reproducible, and precision
b. Incorporates 2 aspect, accuracy & certainty of measurement and representative faithfulness
- Accurate measurement:
a. how close the measurement is to the ‘true value’ of the attribute measure  representation
b. True value’ may not be known (e.g. in accounting accuracy relates to the pragmatic notion of usefulness)

Measurement in Accounting

- 2 fundamental measures  capital & profit  can be defined & derived in various way and the concept change over
time
- 2 notable developments in IASB 2005:
a. Profit measurement and revenue recognition should be linked to timely recognition
b. The fair value approach should be adopted as the working measurement principle

Measurement Issues for Auditors

- The focus of profit measurement has shifted from matching revenues and expenses to assessing the changes in the
fair value of net assets (e.g. immediate recognition of impairment losses
- Auditors must determine whether management has made appropriate and reasonable valuations (e.g. at least 12
methods of valuing intangibles)
- It is possible for several different but reasonable measurements and impairment losses to be recognized by
management if the management have (1) applied the valuation models correctly, (2) used appropriate data, (3) made
appropriate assumptions, and (4) acted in a consistent manner.