Measurement: The Final Chapter in the FASB’s Conceptual Framework

In July 2024, the FASB reached a significant milestone by completing the final chapter of its Conceptual Framework, a project that has been in progress for 50 years. This newly finalized chapter solidifies the foundational principles that guide the Board in standard setting. It also marks the first time since its establishment in 1973 that the FASB has had a fully developed framework in place. The latest addition, Chapter 6, addresses the measurement of assets and liabilities, providing essential guidance on this critical aspect of financial reporting.

Overview of Conceptual Framework

The Conceptual Framework serves as an “operating manual” for the Financial Standards Accounting Board. The purpose of the conceptual framework is to “identify the goals and purposes of financial reporting and the fundamentals are the underlying concepts that help achieve those objectives”.¹The conceptual framework is not a binding set of rules that the FASB must follow when creating accounting standards. Rather, it serves as a set of guiding principles to help the Board make informed decisions during the standard-setting process. As the Board deliberates, their discussion will be guided by a set of foundational concepts, making the process more efficient. Future proposed alternatives that may not be in line with the framework can automatically be eliminated, reducing research and deliberation time.

The framework does not affect current GAAP and does not change any prevailing standards that may be in conflict with the principles outlined. Instead, it informs the Board’s research projects and any changes they may make to those standards going forward. Some ways in which the framework focuses the process of standard setting include providing common points of discussion, furnishing a structured foundation to the thought process in analyzing alternatives, and reducing the amount of judgment required by board members. The other chapters in the Conceptual Framework address other considerations for new standards, such as the purpose of financial reporting, qualitative characteristics of useful financial information, recognition and derecognition, and presentation.

Measurement

The measurement framework provides a set of guidelines for how to choose which price to use in a standard that most faithfully represents the asset or liability. The new chapter states that there are two acceptable prices to consider when assessing a financial statement item:

Entry Price: The price paid (the value of what was given up) to acquire an asset or received to assume a liability in an exchange transaction
Exit Price: The price received (the value of what was received) to sell an asset or paid to transfer or settle a liability in an exchange transaction²

add

Pricing Practices in Practice

Entry Price System

Entry pricing requires that the asset or liability’s initial cost be recorded on the books at its historical cost. The entry price is allocated over its benefit period, where appropriate, which results in an adjusted entry price. Costs from liabilities are also allocated to each reporting period until the liability is settled. Examples of assets and liabilities that currently are measured using the entry price system include PPE and loan liabilities, such as Notes Payable.

Under the measurement concepts articulated in the new framework, assets measured using an entry price should not be reported at amounts exceeding what is recoverable, and liabilities should not be reported at amounts less than what is expected to be settleable. Therefore, remeasurement is sometimes necessary with entry pricing to impair the asset or modify the settlement value to reflect pricing through a transfer or settlement.

Exit Price System

Determining exit pricing is less straightforward than entry pricing. Within exit pricing, there are two possible valuation methods. The most common exit price is fair value, which is the estimation of price from a market participant’s perspective. Entity-specific exit price is the price a specific entity would expect to receive to sell an asset or expect to pay to settle or transfer a liability in an orderly transaction.

add

Pricing Methodology Overview

Exit pricing does not allocate costs to each period, as opposed to entry pricing. Assets and liabilities priced with the exit pricing method must be remeasured at each subsequent reporting date. Any changes to value must be adjusted, with the differences reported in the income statement.

Choosing Between Measurement Systems

The decision of which price to use in the standard should be based on the nature of the asset or liability. The FASB believes that all financial information must possess two characteristics to be effective: relevance and faithful representation. These qualities should guide the choice between entry and exit pricing systems, based on how they apply to the specific asset or liability being examined.

Relevance

Information that is relevant is defined by the FASB as being “capable of making a difference in the decisions made by resource providers”. Relevance is crucial to financial statement users, such as potential investors and lenders. If the exit price for all entities is the same, this system will usually yield the most relevant measures. However, in situations where each entity might have a unique exit price, entry pricing will provide more relevant information.

One factor that might affect the relevance of a pricing system is the uncertainty of measurement. If one pricing system is more unpredictable and volatile, the other pricing system might be the more favorable option. Another factor affecting relevance is differing cash flows and pricing. Transactions involving the same asset or liability in different activities may result in different pricing outcomes.

For example, the same commodities can be acquired for use either as inventory or for trading purposes. When a commodity is held as inventory, entry pricing is generally the more relevant measure because the asset will ultimately be expensed as cost of goods sold when it is sold or used. In this case, the commodity is recorded at historical cost and assessed for impairment as needed. However, when the same commodity is held for trading, its value is primarily driven by market price fluctuations rather than operational use. Accordingly, the commodity is measured at fair value, which represents an exit pricing system. Therefore, the purpose for which the asset is held should inform the selection of the pricing system that is most relevant.

Faithful Representation

Financial information must accurately represent the value of the asset, liability, or transaction it aims to represent. Financial information must be complete, neutral, and free of error in order to be faithfully represented. Estimates can still be free from error in this situation, as long as there were no errors in developing the estimate.

Industry Sentiment

The use of the entry and exit pricing system has been controversial and not always well received. Critics have argued that limiting measurement decisions to only two strategies is too restrictive. Certain existing approaches, such as the cumulative probability method for uncertain tax positions under ASC 740, do not align neatly with either framework. Investors from the CFA Institute noted in their comment letter that the entry pricing system was not as useful as the exit pricing and often had no predictive value for financial statement users.³Financial statement preparers generally disagreed, believing that entry pricing was the better measurement system for the value of an asset or liability.

Academics, preparers, auditors, and investors alike all raised concerns in their comment letter that guidance on subsequent measurement was not addressed. The current Accounting Standards Codification usually describes measurement for assets and liabilities through initial and subsequent measurement. Chapter 6 does not address subsequent measurement and instead focuses solely on initial measurement through the entry and exit pricing systems. Little mention is made of revaluation and recognition in subsequent periods. The prevailing view was that the new chapter should prioritize guidance on initial and subsequent measurement over a focus on entry and exit pricing approaches.

Conclusion

The publication of Chapter 6: Measurement marks the completion of the first fully developed set of foundational principles designed to guide the FASB in shaping future accounting standards. By addressing one of the most complex and debated aspects of financial reporting, this chapter provides a critical framework for evaluating how assets and liabilities should be measured. The incorporation of both entry and exit pricing systems will enhance consistency and transparency, which offers greater clarity for standard setters, preparers, and users of financial statements. With this milestone, the FASB strengthens its conceptual foundation, ensuring a more structured and informed approach to financial reporting in the years ahead.