The Conceptual Framework for Financial Reporting® (Conceptual Framework) states that there are two broad measurement bases: historical cost, and current value. This is because a single measurement basis would not provide the most relevant information to users and so IFRS® standards adopt a mixed measurement basis. This can mean that the totals in financial statements have little meaning. However, it is generally considered that the problems of mixed measurement are outweighed by the greater relevance achieved.

Cost-based measurements are often easier for users to understand, more verifiable, and cheaper for the entity to implement. That said, complexity can still arise, such as where there is a deferred payment or a payment involving an asset exchange. Subsequent accounting after initial recognition is not necessarily straightforward either; matters, such as impairment, must be taken into account and these rely on management judgement and subjectivity.

Current values, such as fair value, may provide more relevant information when measuring assets that an entity intends to sell, such as an investment in equity shares. A business that is profit orientated has processes to transform market input values (inventory for example) into market output values (sales of finished products). Thus, it makes sense that current values should play a key role in measurement.

To meet the objective of financial reporting, information provided by a particular measurement basis must be useful to users of financial statements. A measurement basis achieves this if the information is relevant and faithfully represents the underlying element. In addition, the measurement base needs to provide information that is comparable, verifiable, timely and understandable. The Board believes that when selecting a measurement base, the amount is more relevant if the way in which an asset or a liability contributes to future cash flows is considered. This means that an entity’s business model should affect the measurement of its assets and liabilities. Per IAS 40 Investment Property, property held for rental or capital appreciation can be measured at historical cost or fair value. When deciding on the measurement base in this situation, preparers of the financial statements should consider what purpose the property is held for. If the property is expected to affect the entity’s future cash flows through a sales transaction, then fair value measurement is likely to provide users with more relevant information than a cost-based measurement.

A factor to be considered when selecting a measurement basis is the degree of measurement uncertainty. The Conceptual Framework states that, for some estimates, a high level of measurement uncertainty may outweigh other factors to such an extent that the resulting information may have little relevance. Most measurement is uncertain and requires estimation. Examples include recoverable amount when testing for impairment, depreciation estimates, and fair value measurement at level 2 and 3 under IFRS 13 Fair Value Measurement. However, a measurement with a high degree of uncertainty may still provide the most relevant information about an item, such as for financial instruments where prices are not observable. Disclosure can be used to inform financial statement users about the areas where a measurement uncertainty exists.

Sometimes, when developing an IFRS Accounting Standard, the Board believe that measurement uncertainty is so great that the entity must not recognise an asset or liability. An example of this would be research activities, as covered by IAS 38 Intangible Assets.

Written by a member of the Strategic Business Reporting examining team