Regulatory and conceptual framework - Recognition and measur...

Learning Outcomes

After reading this article, you will be able to define recognition and measurement as applied in financial reporting, explain their practical criteria, and distinguish between measurement bases such as historical cost, fair value, current cost, and value in use. You will be able to apply these concepts to assets, liabilities, income, and expenses, and discuss their advantages and disadvantages for ACCA Financial Reporting (FR) exam questions.

ACCA Financial Reporting (FR) Syllabus

For ACCA Financial Reporting (FR), you are required to understand how transactions and balances are recognised and measured in financial reports, in line with the Conceptual Framework and applicable standards. Specific topics covered in this article include:

• The concept and process of recognition in financial statements
• Recognition criteria for assets, liabilities, income, and expenses
• Measurement bases: historical cost, current cost, fair value, and value in use/fulfilment value
• Advantages and disadvantages of measurement bases for exam and analysis purposes
• Application of fair value and present value techniques

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. What two key criteria must be met before an item is recognised in the financial statements?
2. Which measurement base reflects the actual cash paid for an asset at acquisition, adjusted by subsequent amortisation or depreciation?
3. True or false? Fair value always means the same as market value.
4. Briefly explain what is meant by “value in use.”
5. Which measurement base is typically most objective and reliable, but may become less relevant over time?

Introduction

Recognition and measurement are the basis of financial reporting. They determine what appears in the financial statements and the values at which assets, liabilities, income, and expenses are recorded. The Conceptual Framework and IFRS Accounting Standards set out the principles for recognition—when an item is included in the accounts—and measurement—how it is valued initially and thereafter.

A clear understanding of these principles is essential for exam success, as nearly every FR exam question assumes you can apply or discuss recognition and measurement bases in context.

Key Term: recognition
The process of including an item in the statement of financial position or the statement of profit or loss and other comprehensive income, provided it meets specified criteria.

Key Term: measurement base
The method used to assign a monetary amount to an element in financial statements, such as historical cost, current cost, fair value, or value in use.

Recognition in Financial Reporting

An item is only recognised in financial statements if it both meets the definition of an element—asset, liability, equity, income, or expense—and satisfies the criteria for recognition.

The two main recognition criteria are:

• It is probable that future economic benefits associated with the item will flow to or from the entity.
• The item has a cost or value that can be measured reliably.

Recognising Different Elements

Assets and liabilities: Recognised when it is probable that economic benefits will flow to or from the entity, and the item can be measured reliably.

Income and expenses: Recognised when an increase (income) or decrease (expense) in assets or liabilities has occurred that can be measured reliably and is likely to affect the entity’s equity, excluding owner contributions or distributions.

Key Term: asset
A present economic resource controlled by an entity as a result of past events, with the potential to produce economic benefits.

Key Term: liability
A present obligation of the entity to transfer an economic resource as a result of past events.

Measurement Bases in Financial Reporting

IFRS and the Conceptual Framework identify several measurement bases used to assign values to items in the accounts. Each base has strengths and weaknesses, and its suitability depends on the nature of the item and the circumstances.

The main measurement bases are:

• Historical cost: The original cash amount paid for an asset, or received for a liability, adjusted subsequently (e.g. for depreciation or amortisation).
• Current cost: The cash that would have to be paid to acquire the asset or settle the liability currently.
• Fair value: The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
• Value in use (for assets): The present value of the future cash flows expected to arise from the continuing use of an asset and its disposal.
• Fulfilment value (for liabilities): The present value of the cash that will be paid to settle a liability in the normal course of business.

Key Term: fair value
The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

Key Term: value in use
The present value of the estimated future cash flows expected from an asset’s use and eventual disposal.

Historical Cost

Historical cost is widely used. It is objective—based on actual transaction values. It supports verifiability. However, when prices change, historical cost may become less relevant, as recent values may differ from the reported amounts.

Current Cost

Current cost reflects what an entity would pay to replace an asset or settle a liability now, in its current state. It is more relevant in inflationary environments or where replacement value is critical for decision-making.

Fair Value

Fair value yields information that can be more relevant, especially for items traded in active markets. However, fair value measurements may involve estimates and be less verifiable if markets are illiquid.

Value in Use / Fulfilment Value

These bases are used where cash flows stretch into the future—typically for impairment tests or provisions. Calculated using present value techniques and discount rates, they require significant estimation and judgement.

Advantages and Disadvantages of Measurement Bases

Worked Example 1.1

A company bought a vehicle for $30,000 two years ago. It is depreciated straight-line over five years (no residual value). Today, a new vehicle would cost$36,000. The vehicle’s fair value is $25,000. The estimated value in use is$23,000. What carrying amount appears under each measurement base?

Answer:

• Historical cost: $30,000 – (2/5 ×$30,000) = $18,000.
• Current cost: $36,000 – (2/5 ×$36,000) = $21,600.
• Fair value: $25,000.
• Value in use: $23,000.

Worked Example 1.2

A business acquires an item of equipment for $50,000 and finances it with a$50,000 long-term loan. After three years, the loan’s fair value is $54,000. Which measurement basis should be used for the liability under amortised cost model?

Answer:
For most loans not held for trading, the liability is measured using amortised cost—the initial amount less repayments, plus cumulative finance charges (using the effective interest rate).

Exam Warning

A common exam error is confusing fair value with selling price less costs to sell. Fair value ignores costs to sell unless stated by the relevant standard (e.g., impairment reviews under IAS 36).

Summary

Recognition in financial reporting means including items that meet the definition of an element and satisfy specific probability and measurement criteria. Once recognised, measurement bases determine the monetary amount shown in the statements. The common bases include historical cost, current cost, fair value, and value in use. Each has different merits for reliability, relevance, and comparability, and understanding these differences is essential for interpreting financial results and answering exam questions accurately.

Key Point Checklist

This article has covered the following key knowledge points:

• Define recognition and list the main recognition criteria
• Explain the purpose and application of measurement bases
• Distinguish between historical cost, current cost, fair value, and value in use
• Describe the advantages and disadvantages of the main measurement bases
• Apply measurement bases to assets and liabilities in exam scenarios
• Identify common exam mistakes when discussing recognition and measurement

Key Terms and Concepts

• recognition
• measurement base
• asset
• liability
• fair value
• value in use