Precision and Clarity: Exploring the Role of Measurement Principles in Accounting

To prepare a financial statement, there are certain principles or guidelines which should guide an accountant when measuring line items under the asset category in a financial statement. An example of such a principle is the measurement principle.

What Are Measurement Principles?

Measurement principles are guidelines that determine how assets ought to be valued and reported in financial statements. In essence, it provides a framework for determining the monetary value assigned to assets and plays a crucial role in accurately representing a company’s financial position.

Types of Measurement Principles

There are two primary measurement principles used for assets;

1. Historical Cost Principle/ Cost Principle: This principle states that assets when entered into the financial statement, should be recorded at their original cost when they were acquired. That is, the value of an asset is to be recorded as the amount of cash or cash equivalents paid, or the fair value of non-cash assets given up, at the time of acquiring such asset. When applying this principle, subsequent changes in the market value of an asset are generally not considered when reporting the asset’s value in a financial statement. Historical cost is usually used for assets such as land, buildings, and equipment.

Example:

Where a company purchases a delivery truck for N20,000, the historical cost principle requires that the asset be recorded as N20,000 on the balance sheet even if the market value of the truck increases or decreases over time. Thus, the company will continue to report the asset at its historical cost until it is disposed of.

• Fair Value Principle: This principle states that assets ought to be measured and reported at their current market value. Fair value simply means the price that would be received if the asset were to be sold in an organized transaction between market participants at the measurement date. The fair value principle takes cognizance of the fact that market conditions are prone to change over time and therefore seeks to provide users of financial statements with more relevant and up-to-date information about the value of assets.

Fair value is usually used for financial instruments such as bonds, stocks, and derivatives, where market prices are readily available. Fair value can also be applied to other assets, such as certain kinds of inventory or investment properties, provided that their market value can be reliably determined.

Example:

If XYZ company holds a portfolio of marketable securities, these assets would be reported at their fair value on the balance sheet. Peradventure the market value of a particular security within the portfolio increases or decreases, the company will adjust its reported value accordingly.

It is pertinent to note that the choice of measurement principle depends on the nature of the asset in consideration and the prevalent accounting standards or guidelines within the specific jurisdiction. In some cases, some assets may be measured using a combination of both the historical cost and the fair value principles, depending on their characteristics and the accounting requirements in place.

In summary, the measurement principle shows how an asset is valued and represented on a financial statement. There are two types of measurement principles; the historical cost/cost principle and the fair value principle. The historical cost principle values and represents an asset at the cost for which the asset was bought, while the fair value principle values and represents an asset at the prevalent market price. The measurement principle which should guide an accountant in the preparation of an account statement should be the one prevalent in the jurisdiction. In some cases, the nature of the asset would require that both principles are used in representing the asset on the financial statement.