Financial Accounting: In an Economic Context

THE PRINCIPLES OF FINANCIAL ACCOUNTING MEASUREMENT

There are four basic principles of financial accounting measurement: (1) objectivity, (2) matching, (3) revenue recognition, and (4) consistency.

3. A special method, called the equity method, is used to value certain long-term equity investments on the balance sheet. This method is based on the original cost of the investment, but certain additional adjustments to original cost are made periodically. This method is discussed and illustrated in Chapter 8, which covers long-term investments.

4. Net book value can be applied to an individual balance sheet item, or to the company as a whole, where it is equal to total assets less total liabilities.

The Principle of Objectivity

Financial accounting information provides useful measures of performance and financial position. In doing so, financial accounting statements must provide information about value: the value of entire companies, the value of company assets and liabilities, and the value of the specific transactions entered into by companies.

The economic value of an entity, an asset, or a liability is its present value, which reflects both the future cash flows associated with the entity, asset, or liability and the time value of money.⁵ There is, however, one critical problem with the present value calculation: It assumes that future interest rates and future cash flows are perfectly predictable. This assumption presents no problems in theory, but users of accounting measures ...