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
Assignment of
of numerals
numerals to
to objects
objects or
or events
events
according
(Stevens)
according to
to rules.
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

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

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

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

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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