Measurement Bases – Assets and Liabilities

Financial assets are measured and reported either at fair value or amortized cost. IFRS defines fair value as the amount at which an asset could be exchanged or a liability settled in an arm’s length transaction between knowledgeable and willing parties.

Amortized cost may be defined as the historical cost of an asset after adjustments for amortization and impairment have been made.

Assets and Their Measurement Bases

Current Assets

Current assets are primarily held for trading or are expected to be sold, used up, or otherwise realized in cash within the greater part of a year or one business operating cycle, after the reporting period. They include cash and cash equivalents, marketable securities, accounts receivable, and inventories.

• Cash and cash equivalents: these include demand deposits with banks and highly liquid investments with original maturities of less than or equal to three months. Measuring cash and cash equivalents at amortized cost or fair value is not likely to produce materially different amounts.

• Marketable securities: these include investments in debt or equity securities that are traded in a public market, and whose value can be determined from prices that are obtained in a public market. Further details on these financial assets tend to be provided in notes to the financial statements.

• Trade receivables or accounts receivable: these refer to amounts that are owed to a business entity by its customers for products and services that have already been delivered. They are usually reported at net realizable value, which is an approximation of fair value that is based on estimates of collectability. An allowance for doubtful accounts is made to reflect an entity’s estimate of amounts that will ultimately be uncollectible. Additions to this allowance in a particular period are reflected as bad debt expenses. The balance of the allowance for doubtful accounts reduces the amount of the gross receivables to a net amount which is an estimate of fair value.

• Inventories: these are physical products that a company intends to sell to its customers, either in the form of finished goods or as inputs into a manufacturing process i.e. raw materials and work-in-process. Under IFRS, inventories are measured at the lower cost and net realizable value, while under US GAAP, they are measured at the lower cost or market value. Cost includes all associated costs of purchase, costs of conversion, and all other costs that are incurred in bringing the inventories to their present location and condition. Net realizable value (NRV) refers to the estimated selling price less the estimated costs of completion and costs necessary to make the sale. Market value is the current replacement cost, which cannot exceed the NRV and cannot be lower than the NRV less a normal profit margin. If the NRV or market value of inventory falls below its carrying amount, the company must write down the value of the inventory and reflect the loss in value in the profit and loss statement.

• Other current assets: these are usually not sufficiently material to require a separate balance sheet line item. They include: (i) prepaid expenses, which are normal operating expenses that have been paid in advance; and (ii) deferred tax assets, which represent income taxes that are incurred before the time that the income tax expense will be recognized on the income statement.

Non-current Assets

Non-current assets are assets that are not expected to be sold or used up within the greater part of a year or one business operating cycle. They include property, plant, and equipment, investment property, intangible assets, and goodwill.

• Property, plant, and equipment (PPE): these are tangible assets, including land, buildings, and machinery, that are used in an entity’s operations and expected to provide economic benefits over more than one financial year. Under IFRS, PPE may be reported using either the cost model or the revaluation model. Under US GAAP, however, only the cost model may be used.
  • When the cost model is used, PPE is carried at amortized cost, i.e., its historical cost less accumulated depreciation or depletion, and fewer impairment losses.
  • When the revaluation model is used, the reported and carrying value of PPE is the fair value at the date of revaluation less any subsequent accumulated depreciation.

• Investment property: this is property used solely to earn rental income, capital appreciation, or both. Under IFRS, an investment property may be reported either using the cost model or the fair value model.
  • As is the case with PPE, when the cost model is used, investment property is carried at amortized cost i.e. its historical cost less accumulated depreciation and less any impairment losses.
  • When the fair value model is used, investment property is reported at its fair value. Gains or losses arising from a change in the fair value of investment property are recognized on the income statement in the period in which it arises.

• Intangible assets: these include patents, licenses, and trademarks, or any other asset which is non-monetary, has no physical substance but can be identified. Intangible assets are similar to PPEs in a sense. The US GAAP permits intangible assets to be measured using only the cost model. Under IFRS, intangible assets may be reported either using the cost model or the revaluation model (in the presence of an active market). In the case of internally created identifiable intangibles, IFRS and US GAAP requires them to be expensed rather than reported on the balance sheet. IFRS also requires that an entity separately identifies its research phase and its development phase. Costs incurred internally generate intangible assets during the research phase and must be expensed on the income statement, while costs incurred during the development stage can be capitalized as intangible assets if certain criteria are satisfied. US GAAP, on the other hand, does not permit capitalization as an asset of most costs of internally generated intangibles; all such costs are usually expensed. The costs that are typically expensed under both IFRS and US GAAP include start-up costs, training costs, administrative and other general overhead costs.

• Goodwill: This refers to the excess value created when the purchase price of a company exceeds the buyer’s interest in the fair value of the identifiable assets and liabilities that were acquired. There are two types of goodwill: economic goodwill and accounting goodwill. Economic goodwill is related to the economic performance of an entity and is theoretically reflected in the entity’s stock price. Accounting goodwill, on the other hand, is related to the accounting standards and is reported only when an acquisition is involved. Both IFRS and US GAAP require the capitalization of accounting goodwill that arises from acquisitions. It is, however, not amortized. Instead, it is tested for impairment on an annual basis. Impairment losses are charged against income in the current reporting period and result in the reduction of current earnings and total assets.

• Financial assets: a financial instrument is defined by IFRS as a contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another. Financial instruments are measured either at fair value or amortized cost.
  • Financial assets are measured at amortized cost if a business entity intends to hold a financial asset until maturity and the cash flows of the asset will occur on specified dates and consist of principal and interest payments only. Such assets are referred to as held-to-maturity assets. No unrealized gains or losses are reflected on the balance sheet, income statement, or through comprehensive income.
  • When financial assets are measured at fair value, net unrealized changes in fair value may be recognized either as profit (loss) on the income statement, or other comprehensive income (loss). Realized gains or losses will be reported on the income statement.
  • ‘Held for trading’ securities refer to financial assets that are acquired primarily for selling in the near term. They are measured at fair value and any unrealized gains or losses are recognized as profit or loss on the income statement and therefore reflected in retained earnings within shareholders’ equity.
  • ‘Mark to market’ refers to the process of adjusting the value of a financial instrument to reflect current fair value based on market prices.
  • ‘Available-for-sale’ assets are measured at fair value. Moreover, any unrealized gains or losses are recognized in other comprehensive income and reflected in accumulated other comprehensive income within shareholders’ equity. However, when IFRS9 became effective in 2018, this category of assets ceased to be a choice under IFRS. Nonetheless, this concept is still in the curriculum. IFRS still permits certain equity investments to be measured at fair value with any unrealized holding gains or losses recognized in other comprehensive income. These assets are now referred to as “Financial assets measured at fair value through other comprehensive income” or FVOCI.

Liabilities and Their Measurement Bases

Current Liabilities

Current liabilities are liabilities that are expected to be settled during the normal operating cycle of a business entity. These liabilities are held primarily for trading. In other words, they are due to be settled within one year after the reporting period ends. Examples of current liabilities include trade payables, notes payable, accrued expenses, and deferred income.

• Trade payables or accounts payable: these are amounts that an entity owes its suppliers for goods and services that have been purchased.
• Notes payable: these are financial liabilities that a business entity owes its creditors courtesy of a formal loan agreement.
• Accrued expenses: these are expenses that have been recognized on the profit and loss statement of a business entity but have not yet been paid as of the reporting date.
• Deferred income: this occurs whenever a business entity receives payment before delivering goods and services for which it has been paid.

Non-current Liabilities

Non-current liabilities refer to all liabilities that are not classified as current.

• Long-term financial liabilities: these include loans and notes or bonds payable, and are usually reported at amortized cost on the balance sheet. Upon maturity, the amortized cost of the bond or carrying amount will be equal to its face value.
• Deferred tax liabilities: these arise from temporary timing differences between the reported income (for financial statement purposes) and taxable income (for tax purposes) of a buiness entity. Specifically, deferred tax liabilities occur whenever the taxable income of a business entity, and the actual income tax payable derived from it, is less than the reported financial statement income before taxes, and the income tax derived from it.

Question 1

Which of the following statements is accurate?

1.  ‘Available-for-sale’ assets are measured at amortized cost.
2.  ‘Held to maturity’ assets are measured at fair value, and any unrealized gains or losses are recognized in other comprehensive income.
3.  ‘Held for trading’ securities are measured at fair value and any unrealized gains or losses are recognized as profit or loss on the income statement.

Solution

The correct answer is C.

‘Held for trading’ securities are measured at fair value.

A is incorrect because ‘available-for-sale’ assets are measured at fair value, and any unrealized gains or losses are recognized in other comprehensive income.

B is incorrect because ‘held to maturity’ assets are measured at amortized cost and not fair value.

Question 2

Under IFRS, Property, Plant and Equipment (PPE) could be measured using:

1. The cost model.
2. The revaluation model.
3. Both  the cost model and the revaluation method.

Solution

The correct answer is C.

Under IFRS Property, Plant, and Equipment (PPE) could be measured using the cost model or the revaluation model.

Under US GAAP they can be measured only using the cost model.