Harmonisation or Discord?

The Critical Role of the IASB’s Conceptual Framework

Geoff WhittingtonCFPA, Judge Business School, Cambridge

The Success of IFRS in Harmonisation

• EU adoption, 2000 and 2005• Adoption in Australia and other individual

countries (>100 use IFRS in some form)

• Convergence with USA (Norwalk Agreement, 2002, Roadmap 2005, SEC abandons reconciliation, 2007)

• Convergence with Japan, China, etc.

• Projected adoption by Canada, Brazil, India etc.

The Demand for Harmonisation

• Globalisation of Business:

Lower costs for preparers and users.

Higher confidence (lower cost of

capital?

• Evidence is success of IASC (voluntary)

But Discord also

• EU ‘carve-outs’ of IAS 39 (portfolio hedging and Fair Value option)

• National restrictions of options (Australia)

• Anxiety over multiple interpretations, other than IFRIC (SEC oversight of foreign registrants)

• Variable enforcement standards

Why Discord?

• Transition implies big changes (EU), but once-for-all

• Control and Sovereignty: Ideally, everybody should use the same standard….. and it should be mine

• Underlying these are different cultures and institutions, which lead to different basic concepts, explicit or implicit

( Zeff 2007)

• Explicit conceptual frameworks focus these differences

The Role of the Conceptual Framework

Harmonisation:

• Consistency between standards

• Comparability across entities

• Comprehensiveness (filling gaps: IAS8 )

• Principles base ( simplicity and flexibility)

Discord over choice of concepts

The IASB/FASB Conceptual Framework Revision

• Essential for convergence (and improvement)

• Existing IFRS Framework is similar to FASB, but shorter and some important differences

• Many new adopters had not ‘bought in’ to existing Framework and are objecting to that

(‘ Anglo-Saxon accounting': reinforced by FASB convergence)

The Revision Programme

• A Objectives and qualitative characteristics ( DP published, ED pending)

• B Elements and recognition (active on elements)

• C Measurement (active, but not imminent)• D Reporting entity (active, DP pending)• E Presentation and disclosure (inactive)• F Purpose and status (undetermined output)• G Application to not-for-profit (inactive)• H Remaining issues (tbd)

Some Discordant Themes

• Chapters 1&2, discussion papers, received a hostile reception that surprised IASB

• The central issue is stewardship, but the underlying cultural differences will affect later chapters .

Objective of Financial Reporting (Chapter 1)

• Focus on Present and Future Investors for Decision-making purposes, amongst the wider community of users.

• This leads to a focus on pricing in financial markets.

• Prediction of future cash flows the main objective.

• Stewardship assumed to require same information.

What’s Special about Stewardship?

• Alternative View to Chapter 1

• Stewardship relates to accountability of management for past decisions: an agency relationship.

• Present shareholders have a special relationship as proprietors.

• Reference: Andrew Lennard, Accounting in Europe.

• Non-investor users may also have stewardship needs.

Implications for Financial Reporting

• Stewardship does not rule out current values or information relevant to future cash flows, so it overlaps with decision-usefulness.

• Emphasis differs and can lead to different accounting choices.

• Stewardship requires past transactions and events to be reported. It also recognises that the agent may be tempted to mislead, so that prudence may have a role.

• In the extreme, stewardship may require different information, e.g. related party transactions, directors’ remuneration.

• Future cash flows may be endogenous: interaction between proprietors and management is affected by financial reports.

Evidence of Cultural Origins

• Tim Bush, Divided by a Common Language. US accounting regulation based on securities law (market orientation) but UK based on company law (shareholder orientation).

• The USA has the deepest and most liquid markets and the most active market for corporate control. Hence FASB’s market orientation is unsurprising.

• Continental Europe has a tradition of control through two-tier boards, bank ownership etc., with few take-overs and less active stock markets. The UK and Australia are nearer to the USA: hence, ‘Anglo Saxon Accounting’.

• Continental European objections, articulated by EFRAG, also support stewardship, but wider range of stewards: tax, dividends, etc. (Zeff 2007).

Why does it matter?

• The rest of the Conceptual Framework and many more practical issues in standards are affected by the objective, e.g. measurement.

• Investor orientation leads to entity rather than proprietary orientation (present shareholders less important)

• Chapter 2, is ‘Qualitative Characteristics of Decision-Useful Financial Information

Qualitative Characteristics (Chapter 2)

• Old framework based on trade-off between relevance and reliability

• New framework (Chapter 2) proposes sequential choice starting with relevance

• Reliability replaced by representational faithfulness, indicating concern with substance of an economic phenomenon,

i.e. decision relevance rather than stewardship prevails?

Other Characteristics

• Conservatism and Prudence are now explicitly excluded. Prudence was previously in the IASB framework.

• This detracts from stewardship, e.g. how can we justify impairment tests? (as in IFRS3, Business Combinations).

Elements and Recognition

• Changes in asset & liability definitions to exclude expected benefits and past transactions and events.

• Erosion of recognition criteria :

Element definition changes

Reliable measurement

Benefits will probably flow to the entity

Importance of Recognition Criteria

• A filter for inclusion in accounts, consistent with stewardship.

• Decision usefulness may be satisfied by a valuation test: uncertainty in measurement.

• IAS 37 revision (liabilities) illustrates differences.

IAS37 Revision

• Provisions now to be called liabilities.

• Contingent liabilities dealt with by stand-ready obligations (uncertainty in measurement).

• No probability criterion.

• But where is element uncertainty?

Liability/equity distinction

• A practical issue in IAS32, ‘shares to the value of’’ and proposed IAS39 revision for puttable instruments.

• Present ‘non cash settled’ equity definition has failed.

• But what is the alternative? (narrow equity suits stewardship/proprietary view).

• Practical consequences in classification of and dealings with minority interests.

FASB’s alternatives for Equity definition (Nov. 2007 DP)

• Narrow Equity, “Ownership”: the preferred method

• Broad equity, “Ownership/Settlement”

• “Reassessed Expected Outcomes” (REO) approach, with bifurcation of all credits bearing ownership risk.

AND Related Projects

• Revenue Recognition

• Financial Statement Presentation

Revenue Recognition

• A separate project, but really conceptual (Revenue is an element)

• Is the obligation to a customer based on Fair Value (measurement model), or an entity-specific cost of discharge (customer consideration model)?

Financial Statement Presentation

• Started before Section E of the CF.

• Comprehensive Income in a single statement.

• Is there to be a profit sub-total?

• Re-cycling banned?

• Cohesiveness between financial statements.

AND Things to Come

• Measurement: Resistance to Fair Value.

• Alternative can be replacement cost, not just historical cost.

• Cost based measures are consistent with stewardship and the going concern assumption, made in the present framework…but not in the revision.

• What is the market setting? (Whittington 2008).

• Measurement or Information?

Conclusion

• If you start from the wrong place, it will be more difficult to arrive at the right destination.

• Is the present decision-usefulness objective the right place?