The Role of Present Value-based Measurement in General Purpose Financial Reporting

FORUM: PUBLIC SECTOR GEORGE HAMPTON

THE ROLE OF PRESENT VALUE-BASED MEASUREMENT IN GENERAL PURPOSE

FINANCIAL REPORTING

n July 1994 the Australian Accounting Standards Board and the Public Sector I Accounting Standards Board issued their

Proposed Program for the Development of Concepts on Measurement of the Elements of Financial Statements (hereafter PPDCM 1994). A concepts statement (Statement of Accounting Concepts SAC 5) was scheduled for 1997.’ The boards have placed a high priority on the specification of a preferred basis, or bases, of measurement (PPDCM 1994, para. 39). The measurement concepts will integrate with the concepts set out in SAC 4 (PPDCM 1994, para. 9).

This article focuses on the role of present value- based (W-B) measurement in general purpose financial reports (GPFRs). The appropriateness of PV-B measurement in financial reports is “an issue that will require exposure” (Peirson and McBride 1995, p. 2) because a “framework for using present value in accounting measurement remains to be developed” (FASB 1990, p. i).

Whether SAC 5 adopts PV-B as the preferred conceptual basis measurement, will be influenced by the constraints already imposed by SACS 1-4.’ The developers of the conceptual framework need also, as Chambers (1973, p. 50) observed in relation to policy- making, to “consider the way in which things do work or should work or may work better”. Market structures affect the way in which things work. Attitudes towards the acceptability of PV-B measurement are also important. The conceptually preferred measurement basis needs to be accepted, or at least not opposed, by users, preparers and auditors; otherwise it could face the same fate as current cost accounting (CCA) in the 1970s.3

ATTITUDES TOWARDS

MEASUREMENT THE USE OF PV-B

PV-B measurement is the assignment of numbers to assets and liabilities using the present value attribute

Accounting theorists have advocated different measures of the elements of general purpose financial reports. Australian accounting standards cuwently permit those elements to be measured in a number of ways. At present there is no Australian concepts statement dealing with the topic of measurement. This article examines the proposition that present value-based measurement ought to be, in the context of the Australian conceptual framework, adopted as the “prefewed” conceptual basis of measurement.

22 AUSTRALIAN ACCOUNTING REVIEW VOL. 9 NO. 1 1999

as the basis of measurement. The present value attribute of an asset or liability is the future economic benefit or sacrifice associated with the item, discounted using the present value formula. Assets, as economic benefits, result in net cash (or cash equivalent) flows to a profit-seeking entity; liabilities result in net cash outflows.

The Financial Accounting Standards Board (FASB 1990, p. 4) considered two types of accounting measurements that can involve present values:

Direct measurements. These establish the carrying amount of an asset or liability based on current assumptions and estimates. Most measurements at initial recognition are direct measurements. For example, the initial carrying amount of a finance lease is based on a direct PV-B measurement.

Accounting allocations. These distribute historical amounts to revenue and expense over time. Examples are amortisation of a bond discount or premium using historical discount rates.

In the past there has been a reluctance to depart from cost or cost-based measurements (Chambers 1995, p. 76) and this reluctance persists. SAC 4 (para. 38) refers to cost or other value, and the FASBs Statement of Financial Accounting Concepts (SFAC 1984) No. 5 Recognition and Measurement in Financial Statements of Business Enterprises endors- es measurement at cost. In 1993 Exposure Draft 59 Financial Instruments adopted the cost method as one alternative way of accounting for derivative financial instruments - even though cost “rests on shaky foundations” (Hampton 1996a).

In the US,” where cost-based measurement has been emphasised for decades, recognition of current values in financial statements constitutes a major change. SFAC 5 (FASB 1984) approved the use of current prices: “Information based on current prices should be recognized if it is sufficiently relevant and reliable to justify the costs involved and more relevant than alternative information” (para. 90). Some disagree, including financial analysts (see for example, Knutson 1993, p. 3), objecting to the use of market values in financial statements, not to mention W-B measurements.

There has, however, been a trend towards greater use of PV-B measurement in accounting standards in recent years. Weil (1990) and the FASB (1990, pp. 15,16) provided lists of situations in which accounting pronouncements prescribe PV-B measurement in the US. Those situations are increasing, although the FASB (1990, p.1) has been reluctant to extend the use of present value into new areas without first con- sidering its role in financial reporting generally.

Some Australian accounting standards require the use of present values in the determination of particular asset and liability amounts. Present value-based measurement is used for finance leases (AAS 17/AASB 1008), debt defeasance arrangements (AAS 23/AASB 1014), in determining the accrued benefits of a defined-benefit superannuation plan

(AAS 25), and to measure long-term employee enti- tlements (AAS 30/AASB 1028), claim recoveries receivable (AASB 1023) and obligations from life policies (ED 73). These requirements often, but not always, relate to monetary assets and monetary liabilities where the future cashflows associated with the asset or liability are capable of determination with a high degree of certainty over a given time period. Accounting Guidance Release AAG 10 Measurement of Monetary Assets and Liabilities describes PV-B measurement (using the rate of interest implicit in the contract) as the general principle underlying the measurement of interest-bear- ing assets and liabilities in Australia.

Exhibit A summarises ways in which PV-B measurement has been, or might be, used in GPFRs.

AUSTRALIAN ACCOUNTING REVIEW 23

While in recent years W-B measurements have frequently been used to directly and indirectly measure assets and liabilities, that use has been within an ad hoc approach to measurement, an approach not constrained by a conceptual framework. Under SAC 5 it will be. The preferred conceptual basis of measurement needs to be consistent with the SAC 4 definitions of the elements of GPFR For ease of exposition, this article focuses primarily on one element, assets, and their definition and measurement.

THE DEFINITION OF THE TERM ‘ASSET’ AND ITS

MEASUREMENT The definition of the term asset is a fundamental part of the conceptual framework. The definition determines, in part, what one admits or denies admission to the statement of financial position as assets and consequently what we need to measure. In order to properly aggregate measures of different assets, one, and only one, of the characteristics of the assets ought to be measured. Measures are aggregated in order to prepare a statement of financial position and to determine a measure of performance.

The SAC 4 definition of the term asset emphasises future economic benefit (FEB) or, more precisely, expected FEB, controlled by an entity as a result of past transactions or other past events. FEB is the characteristic to measure, not the past transaction. To arrive at a satisfactory measurement base for the elements of financial statements, we need to distinguish between:

(a) The source of FEB. At the date of purchase, transaction price might be taken as a monetary representation of what management of an entity expects to result in FEB. The market for the source of FEB at a later date is a present market, and the measure of the source then is the present market buying price (Sprouse and Moonitz 1962, p. 33; SAC 4 1995, para. 23). The measurement of the source is not necessarily an acceptable measure of the benefit, especially at a date subsequent to purchase;

(b) FEB itself as one of the SAC 4 characteristics of assets. FEB is the economic benefit that flows to and from purchasers of goods and/or services, or to beneficiaries who receive goods and/or services at no cost or a nominal cost (SAC 4 1995, paras. 18 - 23); and

(c) A measurement of FEB, including (a) as a possibility, which is a forecast or estimate of (b). Only future events will confirm whether those forecasts are materially correct.

The advantage of a measure of (a) is that it is usually quite reliable. However, we must not forget it is (b) we should be trying to measure. Since (b) is not known with certainty, we settle on a measurement under (c). If a PV-B measure of FEB is capable of measurement with sufficient reliability, it might be the best measure of (b).

To Canning (1929) the essence of the value of an asset of a profit-seeking entity (other than cash) was the present value of future net cash receipts (or their

equivalent) into which that asset will be converted (see also Sprouse 1966, p. 111). There is support for this view from other economists and accountants. Alexander (1950, p. 8) pointed out that although in economic theory there is often controversy on the subject of income and capital, “the economist usually considers an asset value as measured by the present worth of associated future net receipts”. The “very basis of economic income is present value of future receipts” (Alexander 1950, p. 59). Even where the assumption of perfect certainty is dropped: “The non-objective character of

economic income under conditions of uncertainty is not alone sufficient basis for its rejection in favor of some more objective standard. For the fact is that future receipts although unknown are the most important measure of the value of an asset, and so the most appropriate basis for the determination of income. Original cost is advocated as a substitute method of valuation largely because original cost can be objectively

measured. In so far as it is objective it is an objective measure of the wrong thing” (Alexander 1950, pp. 59, 60).

As Whittred et aZ(l996, p. 239) pointed out: “ . . . the FASB’s and related definitions [of assets1 arguably imply a present value technique would be the appre priate valuation basis for assets”. The FASB and SAC 4 (1995) definitions of assets are similar. Leo et al‘s Recommendation 11 (1995, p. 120) leaves open the choice of discounted recoverable amount as the prime basis for asset measurement: “If the measurement method chosen for assets is discounted recoverable amount, both identifiable and unidentifiable assets should be recognised initially at this amount.” The SAC 4 definition of an asset is

24 AUSTRALIAN ACCOUNTING REVIEW

futureoriented and benefit-based. Measurement of one characteristic, FEB, addresses the problem of aggregating measurements of different characteristics of assets evident in SFAC 5 (1984, para. 70).

In summary, on the basis of the SAC 4 definition, SAC 5 could adopt Canning’s ideas about the essence of the value of an asset and Leo et ats recommenda- tions, with their implications for PV-B measurement. The present value of FEB would be the conceptually ideal measure, where present value is based on current, not historic, discount rates and estimates of future cashflows for profit-seeking entities.

Cost, mentioned in SAC 4 (para. 38) as a recognition criterion, would then be suitable only as surrogate PV-B measurement of FEB. Where expectations have changed, past purchase price (cost) is not a conceptually attractive measure of FEB at a date subsequent to purchase. Canning (1929) recognised this when he discussed purchases “at the margin”, where the price paid is no greater than the present value placed on the article by the buyer:

“Whatever might have been inferred about the value of the future services of the articles when they were bought can no longer be inferred [at a date subsequent to purchase]. Not only is the future series of services now available a different one from that which was available at purchase, but it is available in different present material circumstances, and it is available for a future course of affairs that looks different from the prospect at the time when the article was bought. This meaning [about price being no greater than present value1 offers no real help at all except at the time of the original valuation entry” (p. 231).

Cost is backward-looking and based upon the sacrifice made; it is not futurebenefit-based as in the SAC 4 definition of an asset. “Accordingly the incurrence of cost is neither a necessary nor sufficient condition for recognition” aohnson 1994, p. 4) of assets. Cost might be suitable as a surrogate PV-B measure of FEB, especially at the date of purchase.

However, before concluding that PV-B is the conceptually best measure for assets we must consider other constraints imposed by existing conceptual framework and other documents.

OTHER CONSTRAINTS

MEASUREMENT These constraints include the requirement that the concepts apply to all reporting entities (SAC 1 1990), both profit-seeking and not-for-profit entities (NFPEs); the objective of accounting adopted and the need for financial statements to discharge accountability obligations (SAC 2 1990); the qualitative characteristics financial information ought to possess to be the subject of GPFRs (SAC 3 1990), as well as attitudes evident in documents such as ASRB Release

IMPOSED ON PV-B

101 that refers to the measurement of individual assets.

The measurement of individual assets

According to ASRB Release 101 (para. 11) a statement of financial position measures individual assets and liabilities of the entity, not the value of the business entity (see also Australian Society of Certified Practising Accountants 1996, p. 6). It is expected that this principle will ultimately be encompassed by concepts statements (see the introductory comments to ASRB Release 101). If so, there are potential problems with the adoption of PV-B measurement.

Even where it is possible to reliably measure present values, it will often be the case that the measure can only be determined for a group of assets. Present value is not a suitable measurement base for individual assets used jointly to produce cashflows.

The objective of financial reporting and accountability

GPFRs are required as a means of communicating relevant and reliable information about a reporting entity to users (SAC 2 1990, para. 11) and discharging accountability (SAC 2 1990 para. 14). SAC 2 (para. 27) says that when GPFRs meet the objective of providing information that is useful for making and evaluating decisions about the allocation of their scarce resources (para. 26), managements and governing bodies of the reporting entities will, at the same time, discharge their accountability to the users of the reports.

Some accounting theorists say future-oriented measures such as PV-B measurements do not discharge accountability obligations. Chambers (1966) maintained that the function of a statement of financial position is not to predict the precise forms which subsequent actions may take (p. 147); anticipatory calculations are “always and inevitably hypothetical” (p. 83). The question of when, if at all, PV-B measurement could be used to discharge accountability obligations is addressed later.

Relevance

There are different approaches to the determination of information relevant for decision-making. One is to focus on decision-makers (AAA 1977, pp. 17-21). This approach is not pursued here. One reason for not doing so is that it has not been helpful in isolating relevant information and measurements. For example, users seem unable to assess the importance of information not previously provided; rather, they often request information that resembles information currently provided (Peirson and Ramsey 1994, pp. 65, 66). Another approach is to decide what is relevant according to a decision model (AAA 1977, pp. 1@17). Sterling (1972) adopted this approach because users are a “diverse lot”. GPFRs will not necessarily provide information that users currently use. They should


provide information that is useful - “appropriate financial information on which to base their decisions” (SAC 2 1990, para. 58).

Accountants and economists support the relevance of PV-B measurement of assets. Thus in 1966 Lemke wrote: “There appears to be wide agreement that conceptually, the soundest measure of an asset’s value is the discounted value of the future cash flows it will generate.” The American Accounting Association (1957, p. 4) was of the same opinion. As already mentioned, more recently Leo et al (1995, pp. 65, 109,119,120) endorsed the use of present values to determine recoverable amount for all assets, and as a possible prime basis for asset measurement.

Reliability

The Financial Accounting Standards Board (FASB 1984, SFAC 5, para. 75) applied the reliability criterion not only to the recognition but also to the measurement (amount) of the elements of financial statements. Under the FASB’s conceptual framework, statements about and measures of past transactions and events need to be reliable (confir- matory role). In addition, “Future events are implicitly embodied ... in the asset definitions (future economic benefits)” uohnson 1994, p. 2). Because assets are defined in terms of the future, we are dealing with the realm of the unknown, ranging from a future that we can predict with almost complete confidence to a future of which we have little or no idea. As Johnson (1993, p. 78) said, in referring to the many uncertain items in financial statements: “Only future events can confirm whether those decisions are materially correct.” These remarks apply to statements about future transactions and events (predictive role) and, since the asset characteristic to measure is expected future economic benefit, to measurements of FEB.

Some theorists regard PV-B measurement as not being reliable and hence not suitable for GPFRs. Sterling rejected information about future cashflows for a number of reasons. One is that we “have no way of knowing what the future holds, and there are many conflicting views about it” (1972, p. 208). According to Chambers (1980a, p. 29) user value, represented

by the discounted net proceeds of the use of an asset, is “entirely subjective”.

However, reliability of information does not fall into two discrete categories: reliable or not reliable. Reliability is best depicted by a continuum, where the extremes are completely reliable and completely unreliable. When we attempt to predict the future, it is difficult to know where on the continuum a prediction should appropriately be placed. For exam-

ple, information about the possible outcome of legal action might be relevant, but difficult to determine with any confidence, and even more ddficult to quantify reliably. Since PV-B measurements can range over the reliability continuum, they might or might not be viewed as sufficiently reliable to use in GPFRs. The quest for reliability implies

PV-B measurements need to satis& a number of conditions before being accepted in GPFRs5. Leo et a1 (1995, p. 120) recommended that an independent expert’s opinion be required when discounted recoverable amount is used to measure an asset initially or for the first revaluation. Such an opinion would lend credibility to a PV-B measurement. We must rely on the best evidence

available to decide whether a PV-B measurement is sufficiently reliable. Probable (an essential characteristic of an asset under SFAC 6) means “that which can reasonably be expected or believed on the basis of available evidence or logic but is neither certain nor proved” (SFAC 6, p. 10, quoting from Webster’s Dictionary). The quest for reliability is complicated because management intention might be part of that evidence. One cannot sensibly measure FEB

without knowing whether management intends to (a) sell or (b) retain and use an asset. For (a) the selling price of the asset is an

appropriate measure; for (b) value in use is an appropriate measure. There are problems associated with the use of managerial intention and expectation as the basis for measurement. A criticism of Exposure Draft (ED) 59 Financial Instruments (1993) and one of the reasons for not proceeding with it was the use of managerial intention (see ED 59 para. 104) to determine the appropriate measurement method for financial instruments. In addition, management


expectations and those of the marketplace might differ.

Relevance and Reliability

Ideally information should be both relevant and reliable. SAC 3 (para 7) acknowledges there is often tension between the requirements that information be relevant and reliable. The term information can embrace past-factual, present-factual, future expectational or future intentional information (see Chambers 1980b, pp. 28, 29). Information could be relevant and reliable; relevant but not reliable; reliable but not relevant, and some information might be neither.

The FASBs Statement of Financial Accounting Concepts No. 2 (para. 34) indicated that relevance and reliability must exist “to a minimum degree”, and that often one quality impinges on the other. “Reliability may suffer when an accounting method is changed to gain relevance, and vice versa” (para. 90). Relevance depends on use; reliability on the circumstances of its gathering (Staubus 1977, p. 200).

While both Sterling (1972) and Chambers (1980a) rejected W-B measurement as a reliable basis for external financial reporting, the FASB has endeavoured to balance the relevance of information with the need for reliable information about the existence and amount of an asset (SFAC 5, para. 75).

“Unavailability or unreliability of information may delay recognition of an item, but waiting for virtually complete reliability or minimum cost may make the information so untimely that it loses its relevance. At some intermediate point, uncertainty may be reduced at a justifiable cost to a level tolerable in view of the perceived relevance of the information. If other criteria are also met, that is the appropriate point for recognition. Thus, recognition may sometimes involve a trade-off between relevance and reliability” (SFAC 5, para. 77)

SAC 4 (1995, para. 28) requires that an asset be recognised when and only when it is probable (more likely rather than less likely) that the FEB will even- tuate. Even so, a reliable (more rather than less like-

ly) W-B measurement of FEB might not be available. The dual requirements of relevance and reliability lead to the conclusion that no one measurement base is likely to be used in practice for all entities, for all assets, all the time, where W-B measurement is the preferred basis.

While lack of reliability is sufficient for some, but maybe not others, to reject W-B as the preferred conceptual measurement basis6, a conclusion to reject is reinforced when we give consideration to assets of NFPEs.

Assets of NFPEs

When Canning (1929, p. 40) wrote: “All will agree that future income constitutes the sole source of enterprise valuation,” he used the term enterprise to refer to business enterprises (p. 234); he did not refer to NFPEs. More than 60 years later, SAC 4 seems to have embraced notions similar to Canning’s about the nature of assets as future benefits, and perhaps will adopt his approach to the measurement of assets. However Canning’s ideas about measurement have no application to many of the noncurrent assets of NFPEs (see Hampton 1996b, p. 86).

The Australian conceptual framework adopts the notion that there are no conceptual differences between accounting for profit-seeking entities and accounting for NFPEs. However, there might be different problems in the measurement of FEB.

The elaboration of the SAC 4 definition of the term asset differs depending on whether the entity control- ling the asset is (a) a profit-seeking entity or @) a NFPE. The dehition for (a) emphasises FEB expected to flow from and to the entity. The defmition for @) emphasises FEB expected to flow to the recipients of goods and/or services provided to them by the entity. Exhibit B illustrates the difference between (a) and (b). Where a NFPE holds an asset and does not charge for goods and services stemming from that asset, the present value of casMows to the entity cannot be used to measure the asset. Such assets do not directly produce related cashflows - unless of course, there is a residual value. Where an entity makes only a nominal charge for goods and/or services provided


by a noncurrent asset, the “asset” might generate a negative net present value, and as such has the characteristic of a liability (Mautz 1981 and 1988; Hampton 1996b) rather than an asset.

When no FEB flows to a NFPE in the form of casMows or their equivalent, it might be possible to impute a cash equivalent to FEB. One possible approach would be to use the contingent valuation method described by Mitchell and Carson (1989) to survey beneficiaries and reveal their personal valuations of the FEB they receive (see also Hampton 1996b). Unless an approach such as this is used, W-B measurement loses much of its appeal because it does not apply to NFPEs.

Recent accounting documents (see, for example, AAS 27, para. 41 in respect to local governments; Rowles 1992, p. xii) have suggested that measurement at written-down current cost7 is appropriate for profit-seeking entities and NFPEs, whereas a measure based on firedicted actual future cashflows to the entity might not even be possible for the latter.

In addition to satisfying constraints imposed by existing conceptual framework and other documents, measurement under SAC 5 needs to consider the way markets operate.

MARKET STRUCTURES

A N D THEIR IMPLICATIONS

MEASUREMENT The concepts statements apply to all reporting entities and their financial reporting obligations (SAC 1). Those reporting entities operate in a variety of market structures. SAC 5 must accommodate all the different types of market structures, and recognise their implications for GPFRs.

Beaver (1989) examined financial reporting in a number of different settings or market structures: (a) perfect, complete markets8 with certainty; (b) perfect and complete markets without the assumption of certainty; and (c) imperfect and incomplete markets. Based on Beaver’s definitions of perfect markets and complete markets, in both (a) and (b) exit price, entry price and value in use (or present value) are equal (Beaver 1989, pp. 56, 57, 86) - there is an

FOR PV-B

identity of values. In these circumstances valuation or measurement of assets is a well-defined process (p. 101). One can provide a report that discharges accountability obligations and provides information about expectations of the future at the same time, because current market price equals present value.

Because of the identity of values (Staubus 1977, p. 209; Beaver 1989 pp. 53,55; FASB 1984, para. 68; A M 1994, p. 114) the perfect market model provides the same endorsement for measurement at entry

price, exit price, and present value as determined by management and the market. Further, it seems that “there is no role for accountants in providing these measures” where the perfect market assumptions hold since the information is “either already available or can be costlessly calculated” (Bromwich 1984, pp. 186, 188). Accounting is irrelevant in perfect markets.

Many economists, including Alfred Marshall in Industry and Trade (1919), have expressed the view that the conditions of perfect competition and pure monopoly seldom, if ever, exist in the real world (see also Chamberlin 1933, p. xi; Braddock and Archbold 1970, p. 120; Cohen and Cyert 1975, p. 52). To Chambers (1995 p. 82) there is a universal absence of “perfect” conditions. Tinker et al (1982, see Jones et al 1995, p. 573) refer to the “fairyland of perfect competition” that “fails to consider institutional imperfections”. This matter is important to GPFRs because measurement problems are greater in imperfect markets. When markets are imperfect and incomplete, one would not expect the identity of values to necessarily hold.

In some market situations the PV-B measure of an asset might exceed the transaction cost of the asset at the date of purchase, or the market price at a date subsequent to purchase. Thus management might

expect pure profits from the purchase of fixed assets. Fixed assets purchased at a price less than equilibrium price “are expected to yield pure profits - their present values are positive” (Barton 1974, p. 669). Although most likely in imperfect markets, this situation could occur in almost any type of market struc- ture, including a perfect market not at equilibrium. On the other hand, a PV-B measure might be less than market price, especially at a date subsequent to purchase. Supply and demand analysis provides


support for this conclusion. Subsequent to purchase, “ . . . current market prices may change because of various changes in market supply or demand conditions and there is no necessary relationship between current replacement costs of misting assets and their present values: current replacement costs may be greater or less than the present values of existing fixed assets ... The present values of a given fixed asset are likely to vary enormously between firms” (Barton 1974, pp. 670,671 - emphasis in original).

Based on the SAC 4 definition of assets, transaction cost has already been rejected as a conceptually attractive measure in its own right. Three measurements - exit price, entry price and present value - remain as possible measures of assets in GPFRs. Given that (a) some markets, perhaps most or all markets, are not perfect; (b) past transaction price is not a conceptually suitable measurement, even at the date of a transaction; (c) a PV-B measure might differ in amount from the related market value; and (d) any of a number of relationships may hold between exit price, entry price and user value (Parker and Harcourt 1969, p. 17), the question is how to measure assets in GPFRs using one of these non-transaction-based measures. As the analysis in this article has shown, it is not clear, based on principles consistent with existing SACS and the way markets operate, that PV-B measurement ought to be the preferred basis.

CONCLUSION PV-B measurement appears to satisfy some of the requirements of a conceptually preferred measure. It has been increasingly used in financial reporting, perhaps leading some to view it as an accepted and acceptable measure. A PV-B measurement is often considered the only satisfactory approach to measurement - for example, the measurement of the accrued benefits liability under a definedcontribu- tion superannuation scheme. The definition of assets in terms of FEB arguably implies PV-B measurement. Economists and accountants support its relevance, as does the concept of perfect markets (for what that is worth). The reliability problem caused by the absence of common expectations in imperfect

markets could be reduced by requiring an independent expert opinion to support a PV-B measurement.

However, in the context of (a) imperfect markets, (b) attitudes that have prevailed for decades, in

particular a reluctance to depart from cost-based measurement and countenance the use of even market values, and (c) some SAC 1-4 constraints, no clear and compelling case for the conceptual appropriateness a of PV-B measure of FEB appears to emerge. It would perhaps be rather naive to expect it to. In 1966 Sprouse (p. 114) claimed “the repertoire of compelling arguments [for direct valuation procedures based on future cashflows and indirect valuation procedures based on current replacement costs] has been all but exhausted without noticeable impact”. The reason might be that the “compelling” arguments are not compelling enough. The need for the preferred conceptual basis of measurement to apply to NFPEs is an additional constraint that SAC 5 must consider, a constraint with which Sprouse (1966, p. 103) did not deal when he wrote about measurement for “publicly held corporations”.

There is an important point to be made relating to the ambivalent and conflicting signals identified in this article about PV-B measurement as the preferred conceptual basis for measurement. Satisfaction of a number of, but not all, necessary constraints is not a sufficient condition for the adoption of PV-B measurement. On the other hand, where PV-B measurement does not satisfy a constraint or number of constraints, that might be sufficient to warrant its rejection unless steps can be, and are, taken to rectify the problem($. This is the situation regarding (a) the non-applicability of the concept of PV-B measurement to NFPEs; (b) perceived reliability problems with attendant

reluctance to extend the use of PV-B measurement; and (c) the need for GPFRs to discharge accountability obligations. In imperfect markets it might not be possible to provide a GPFR that recognises the FEB of assets at a PV-B measurement and discharges accountability obligations at the same time. In addition, there is often an inability to measure individual assets when PV-B measurement is used.


If SAC 5 does not adopt PV-B measurement as the conceptually preferred measurement basis, it could be used (a) as a surrogate for some other ideal type of measurement; (b) in deprival value accountingg; or (c) in a recoverable amount test for profit-seeking entities.

Before his retirement from fill-time employment in 1997, George Hampton was a senior lecturer at Charles Sturt Univenity, Bathunt. The author thanks the referees for their helbful and constructive comments.

NOTES 1.

2.

3.

4.

5.

6.

7.

The Australian Accounting Research Foundation subsequently indicated that an accounting theory monograph on measurement would be issued in 1997. This monograph has not yet been issued. The article does not aim to critically evaluate the conceptual framework; rather its implications for measurement of the elements of GPFRs are considered. This is the approach adopted by Rowles (1992, p. 61) when he examined the measurement of infrastructure and heritage assets. Opposition to the UK proposals for CCA culmi- nated in a 1977 resolution by the Institute of Chartered Accountants in England and Wales, that CCA not be made mandatory. In 1978 the Institute of Directors in Australia opposed the introduction of CCA, saying that it “cannot be sup ported at this time” because of the potential for confusion, scope for inconsistency, subjectivity and misinterpretation. With the movement towards international har- monisation of accounting standards what h a p pens in other countries is important in terms of the development of accounting within Australia. Reliable measurement of FEB based on a direct PV-B measurement is not always possible (Canning 1929; Sprouse 1966). Direct measurement (or valuation as Canning used the term) relies on direct evidence of the amounts, timing and uncertainty of future cashflows. Where there is contractual evidence the reliability of the cash- flow potential data is strong. Canning (1929), recognising that is not always possible to directly predict future cashflows, wrote about the indirect valuation of items such as assets. In a similar man- ner Sprouse (1966, p. 111) distinguished between direct and indirect measurement procedures. As discussed later in the article, this lack of reliability stems from the absence of common expectations by market participants in imperfect markets. This suggestion leads to the need to assess the usefulness of current cost as a measure of FEB. Revsine (1973) attempted to provide a conceptual foundation for replacement cost accounting by linking replacement values with future earnings. To Ma and Miller (1975, p. 69) that link is tenu-

ous. The suggestion is not discussed here, although some of the analysis in this article relates to it.

8. In terms of Beaver’s (1989, p. 50) definition, in perfect markets there are zero transaction costs, no opportunities to earn abnormal returns and invariant prices. In complete markets, a market exists for all commodities and claims.

9. Use of PV-B measurement of FEB as the preferred basis of measurement is different from the application of deprival value to measure FEB. The determination of deprival value is encapsulated in the following mathematical expression uohnstone and Gaffikin 1996, p. 52): deprival value = min [RC, max (NPV, NRV)], where RC = current replacement cost, N W = net present value (or economic worth or value in use), and NRV = value in exchange. In most cases replacement cost would be used as the value for an asset (Baxter 1975, p. 125); this would not be the case where the asset was not worth replacing. In the latter instance the maximum of N W and NRV is used as the deprival value. The term deprival value is not synonymous with the termfuture economic value, as used in SAC 4. The loss from deprival is not necessarily the same as the gain from acquisition (see Baxter 1975, p. 126). “In other words, so long as the contribution exceeds replacement cost, it is irrelevant, and deprival value can then be found without reference to the asset’s fiture earnings or cost savings” (Baxter 1975, p. 128, emphasis in original). If PV- B measurement was adopted as the preferred conceptual basis, a reliable PV-B measurement of an asset which is higher than current cost might be used; but it would not be used as the asset’s deprival value.

REFERENCES AAA (American Accounting Association), Committee on Accounting Concepts and Standards, 1957, Accounting Reporting Standards for Corporate Financial Statements and Preceding Statements and Supplements, Columbus, Ohio.

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The Role of Present Value-based Measurement in General Purpose Financial Reporting

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