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GODFREY

HODGSON
HOLMES
TARCA

CHAPTER 5
MEASUREMENT THEORY
Importance of measurement
Campbell:
The assignment of numerals to represent
properties of material systems other than
numbers

Assignment of numerals to objects or events


according to rules. (Stevens)

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Importance of measurement
Involves linking the formal number system to
some property of objects or events by means
of semantic rules
e.g. semantic rules in accounting are represented
by transactions
In accounting we measure profit by:
first assigning a value to capital
then calculating profit as the change in capital
over the period
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Scales
Every measurement is made on a scale
Created when a semantic rule is used to relate
the mathematical statement to objects or
events
The scale shows what information the
numbers represent

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Nominal scale
In this scale, numbers used only as labels
Numbers represent classification
e.g. numbering footballers
e.g. the classification of assets and liabilities
into different classes

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Ordinal scale
In this scale, rank orders objects with respect
to a given property
e.g. tallest to shortest person
e.g. investment alternatives that are ranked 1, 2, 3
according to the size of their net present values
Intervals between the numbers are not
necessarily equal

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Interval scale
In this scale, rank orders objects with respect
to a given property
The distance between each interval is equal
and known
An arbitrarily selected zero point exists on the
scale
e.g. celsius temperature scale
e.g. standard cost accounting

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Ratio scale
In this scale, rank orders objects with respect
to a given property
Intervals between objects are known and
equal
A unique origin exists
e.g. measurement of length
e.g. use of dollars to measure assets and liabilities

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Permissible operations of
scales
Invariance of a scale means that the
measurement system will provide the same
general form of the variables, and the decision
maker will make the same decisions
This is not the case in accounting there is
more than one accounting system
The information they provide will differ and
different decisions will be made

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Permissible operations of
scales
Nominal and ordinal scales
no arithmetic operations
Interval scale
addition and subtraction
Ratio scale
all arithmetic operations

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Types of measurement
There must be a rule to assign numbers before
there can be measurement
The formulation of the rules gives rise to a
scale
Measurement can be made only on a scale

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Fundamental measurements
Numbers are assigned by reference to natural
laws
Fundamental properties are additive
e.g. length, number and volume

In accounting there is considerable debate


over the nature of fundamental value

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Derived measurements
Is one that depends on the measurement of
two or more other quantities
Depends on known relationships to
fundamental properties
e.g. the measurement of density depends on the
measurement of both mass and volume
e.g. the measurement of profit depends on the
measurement of both income and expenses

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Fiat measurements
Typical in social sciences including accounting
Based on arbitrary definitions - e.g. of profit
Numerous ways in which scales can be
constructed
May lead to poor levels of confidence in the
scale e.g. there are hundreds of ways to
measure profit

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Reliability and accuracy
No measurement is free of error except
counting
e.g. we can count the chairs in a room and be
exactly correct

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Sources of error
The sources of error include the following:
Measurement operations stated imprecisely
Measurer
Instrument
Environment
Attribute unclear
Risk and uncertainty
We need to establish limits of acceptable error

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Reliable measurement
What is reliable measurement?
proven consistency
repeatable or reproducible
precision

Reliability incorporates two aspects


accuracy and certainty of measurement
representative faithfulness

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Accurate measurement
Consistency of results, precision and reliability
do not necessarily lead to accuracy
Accuracy has to do with how close the
measurement is to the true value of the
attribute measure - representation
True value may not be known
e.g. in accounting accuracy relates to the
pragmatic notion of usefulness

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Accurate measurement
Many accounting measurements are on a ratio
scale
This is the most informative scale
Weakest theoretical foundation as they are
fiat measurements

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Measurement in accounting
Two fundamental measures
capital & profit
Capital and profit can be defined & derived in
various ways
Concepts of capital & profit have changed
over time
number of concepts of fundamental measurement

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Measurement in accounting
Two notable developments in international
standards (2005, IASB)
profit measurement and revenue recognition
should be linked to timely recognition
the fair value approach should be adopted as the
working measurement principle

At no stage has the principle of capital maintenance


been explicitly discussed

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Measurement issues for
auditors
The focus of profit measurement has shifted
from matching revenues and expenses to
assessing the changes in the fair value of net
assets
e.g. immediate recognition of impairment losses

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Measurement issues for
auditors
Auditors must determine whether
management has made appropriate and
reasonable valuations
e.g. at least 12 methods of valuing intangibles

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Measurement issues for
auditors
It is possible for several different but
reasonable measurements and impairment
losses to be recognised by management
These would all be acceptable to an auditor if
management have
applied the valuation models correctly
used appropriate data
made appropriate assumptions
acted in a consistent manner
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Summary
Measurement involves the formal linking of numbers to some property or
event via semantic rules
Rules used to assign numbers are determined according to four scales
Invariance of a scale means the measurement system will provide the
same general form of the variables and the decision maker will make the
same decisions
There are three different types of measurement
Reliability refers to consistency, and accuracy refers to the representation
of a fundamental value
The two fundamental measures in accounting are capital and profit and
they are both derived measures
The existence of alternative valuation methods creates auditing issues

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Key terms and concepts
Measurement
Nominal scale
Ordinal scale
Interval scale
Ratio scale
Invariance of a scale
Fundamental measurements
Derived measurements
Fiat measurements
Reliability in measurement
Accuracy in measurement
Capital and profit as derived measurements
Appropriate measurement in an auditing context

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