4.5 Explain the difference between current and replacement costs.

Replacement cost: 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.

4.6 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.

4.8 Identify factors that may influence the choice of measurement approach.
Discuss how the measurement approach adopted affects 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.
Case Study (Textbook pg112)
1. What is meant by the term ‘market context’? Why is context so important in
accounting measurement?
Market context refers to the conditions and circumstances of the market in which an
asset or liability is traded or valued. In accounting measurement, market context is
important because it affects the determination of the appropriate measurement basis
for an asset or liability. The market context can influence the choice of measurement
basis because different measurement bases may be more appropriate in different
market context
Measurement method used in the profession should be selected with the market
context. We need to have that in order to make sure that it could reflect market
conditions and also to meet users’ needs. It will help preparers to prepare and provide
the most accurate and decision useful in accounting information. Information
provided will be more useful and meaningful especially for investors to make
decision.
If the market is to play a role in valuation, we want to ensure that the resulting values
reflect the fundamental values of the assets and the operations of the market forces
does not lead to over or under values of the asset. If it is over or under valued, it will
lead to misappropriation of asset.

2. Is adoption of a single measurement base approach likely to work in practice?

Justify your response.
Single measurement base is unlikely to work in practice because the requirement for
that is a perfectly competitive and complete market. In reality, market will always be
imperfect, hence the need of accounting information asymmetry will always exist
where not all market participants will know all the information relevant to a
transaction. When the market setting is imperfect, we should regard the account as
providing useful information for decision making rather than definitive measurement.
A market has different users. A single measurement base approach not best reflect
market condition or meet users need at a specific time.
Some argue that there is no single measurement base and should focus more on
information. A single measurement base approach is not sufficient and reliable
enough because of the situations of their business activities. According to
practitioners, the most important is the information provided by the accounting
preparers in the financial statements. The decision to be made on single measurement
approach is not that important.

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
According to standard setters, it is ok to have single measurement. Although market is
imperfect, it still provides a lot of information. Market has its own uniqueness
because market always can provide information(market price based on full
information for every asset and liability). Since market is providing full set of
information, single measurement can be considered to be applied.
Any market, especially non- active market, businesses can appoint expert to give the
valuation. It can lead to difficulties in making comparison from one entity to another
entity if businesses is using mixed measurement approach. This is because it will arise
the tendency of having additivity problem. In order to prevent this problem in the
industry, it is recommended to use single measurement base approach.
Fair value is manageable to be used. They promoting fair value as a measurement
base. Fair value is favour due to its relevance measure market expectation and future
cash flows to be derived by the entity reflecting the market fees rather than the views
of management associated with the entity.