Till now in this blog series, we have learned what financial statements are made of – assets, liabilities, equity, income and expenses. But there is one more important question that always comes up in accounting:
At what value should these items be shown in the financial statements?
For example, if a company bought a machine for ₹5 lakh ten years ago, should it still be shown at ₹5 lakh today? Or should it be shown at today’s market value? Or at the amount it can be sold for?
This is where measurement comes into the picture.
The framework for financial statements gives different measurement bases to decide the money value of assets and liabilities. Let us understand them one by one.
What is Measurement in Accounting?
Measurement is the process of assigning a monetary value to elements of financial statements so that they can be recorded in the Balance Sheet and Profit & Loss Account.
In simple words:
“Measurement means deciding the amount at which an asset or liability will appear in the books.”
The framework recognises four main measurement bases:
- Historical Cost
- Current Cost
- Realisable (Settlement) Value
- Present Value
1. Historical Cost
Meaning
Historical cost means the original price paid to acquire an asset.
For example, if a company buys a machine for ₹10 lakh, that ₹10 lakh is its historical cost.
Assets are recorded at:
- Cash paid
- Or fair value at the time of purchase
Liabilities are recorded at:
- The amount of money received
- Or the amount expected to be paid
Why Historical Cost Is Used
Historical cost is:
- Simple
- Reliable
- Easy to verify
That is why most accounting standards mainly use historical cost.
Example
Suppose:
- A company buys land for ₹20 lakh
- After 5 years, its market value becomes ₹50 lakh
Under historical cost, land will still be shown at ₹20 lakh.
2. Current Cost
Meaning
Current cost means the amount that would have to be paid today to buy the same asset.
In simple words:
“What will it cost if we buy this asset now?”
Example
A machine was bought for ₹1 lakh five years ago. Today, the same machine costs ₹3 lakh.
So:
- Historical cost = ₹1 lakh
- Current cost = ₹3 lakh
Current cost reflects the present economic value of assets.
Why Current Cost Is Useful
It shows:
- Replacement cost
- Real financial strength of a business
But it is not always used because market prices keep changing.
3. Realisable (Settlement) Value
Meaning
Realisable value means the amount that can be received if an asset is sold today.
For liabilities, it is the amount that will be paid to settle them.
In simple words:
“What will we get if we sell it? What will we pay if we settle it?”
Example
If a machine can be sold today for ₹2 lakh, then:
- Realisable value = ₹2 lakh
If a loan of ₹1 lakh can be settled today by paying ₹95,000, then:
- Settlement value = ₹95,000
This basis is useful when a business is not a going concern.
4. Present Value
Meaning
Present value means the current worth of future cash flows.
It is based on the idea that:
“Money today is more valuable than money tomorrow.”
So, future cash receipts or payments are converted into today’s value using a discount rate.
Example
Suppose:
- A machine will generate ₹10,000 after one year
- Interest rate is 10%
Present value = ₹10,000 ÷ (1 + 0.10) = ₹9,091
This means ₹9,091 today is equal to ₹10,000 after one year.
Why Present Value Is Important
It shows:
- True economic value of assets
- Actual burden of liabilities
It is commonly used in:
- Long-term loans
- Pension obligations
- Investment decisions
Which Measurement Method Is Used?
In real life, companies do not use only one method. They use a mix of methods.
For example:
- Fixed assets → Historical cost
- Inventory → Lower of cost or net realisable value
- Investments → Fair value
- Loans → Amortised cost
Accounting standards decide which method to use.
Impact of Measurement on Profit
Different measurement bases give different profit figures.
For example:
- Higher asset value = higher equity
- Lower asset value = lower profit
So, measurement directly affects:
- Profit
- Net worth
- Financial ratios
That is why choosing the right measurement basis is very important.
Conclusion
Measurement is one of the most important parts of accounting. It decides how much value appears in financial statements.
The four measurement bases:
- Historical cost
- Current cost
- Realisable value
- Present value
together help businesses present a fair and realistic financial picture.
In the next blog, we will explore Capital Maintenance and Profit Determination, which explains how profit is affected by changes in asset values.
Frequently Asked Questions (FAQs)
1. What is measurement in accounting?
Measurement means deciding the monetary value at which assets and liabilities are recorded in financial statements.
2. What are the main measurement bases?
The four main bases are historical cost, current cost, realisable value, and present value.
3. Why is historical cost commonly used?
Because it is simple, reliable, and based on actual transaction values.
4. What does current cost show?
It shows how much it would cost to replace an asset at today’s price.
5. What is realisable value?
It is the amount an asset can be sold for or a liability can be settled for in the present.
6. What is present value?
Present value is the current worth of future cash inflows or outflows after discounting.
7. Why does measurement affect profit?
Because changing asset or liability values changes equity, which directly affects profit.
