issues arising from the iasb discussion paper “fair value...
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Issues arising from the IASB Exposure Draft “Conceptual Framework for Financial Reporting”: Comments from the British Accounting and Finance Association’s Special Interest Group in Financial Accounting and Reporting1
Preface
The Financial Accounting and Reporting Special Interest Group (FARSIG) is a special
interest group of the British Accounting and Finance Association (BAFA). Its technical
committee is charged with commenting on discussion papers and exposure drafts issued by
standard setters on issues relating to financial accounting and reporting. Its views represent
those of its members and not those of BAFA.
BAFA is the representative body for UK accounting academics and others interested in the
study of accounting and finance in the UK. FARSIG is BAFA’s designated group specialising
in issues relating to financial reporting. This response has been formulated by Carsten Erb,
Omiros Georgiou, Mike Page, Christoph Pelger, Ioannis Tsalavoutas, Pauline Weetman and
Geoff Whittington with comments from Mike Jones and has been approved by the FARSIG
Technical Committee.
We have necessarily been sparing with the literature we have cited in this response and if you
need any supportive academic references we will be happy to supply them.
Contents
Chapters 1/2 The objective of general purpose Carsten Erb 2
financial reporting and the Omiros Georgiou
qualitative characteristics of Christoph Pelger
useful financial information
Chapter 3 Financial statements and the Pauline Weetman 9
reporting entity
Chapter 4 The elements of financial Mike Page 11
statements
Chapter 5 Recognition and derecognition Mike Page 13
Chapter 6 Measurement Omiros Georgiou 14
Geoff Whittington
Chapter 7 Presentation and disclosure Ioannis Tsalavoutas 18
Chapter 8 Concepts of capital Pauline Weetman 20
and capital maintenance
1 Edited by David Oldroyd, Chair FARSIG Technical Committee
2
Carsten Erb
Düsseldorf University
Omiros Georgiou
Manchester University
Christoph Pelger
Innsbruck University
Chapters 1 and 2 – The objective of general purpose financial reporting and the qualitative characteristics of useful financial information
We welcome the IASB’s decision to resconsider the chapters on the objectives of
financial reporting and the qualitative characteristics. This clearly corresponds to the
demands by many constituents who were not satisfied with several of the changes that
had been made in the joint framework revision by the IASB and FASB. We generally
perceive that in the ED the IASB suggests to reemphasise and reintroduce concepts
which were part of the early (pre-2010) IASB framework and deem this an
appropriate way forward. However, there are several aspects where in our view the
conceptual reasoning might be improved and the IASB’s opinion might be clarified.
Answers to specific questions
(a) Do you support the proposal to give more prominence, within the objective of
financial reporting, to the importance of providing information needed to assess
management’s stewardship of the entity’s resources?
We support your proposal to give more prominence to the stewardship role of
accounts. As we have discussed in our comment letter to your 2013 discussion paper,
we consider stewardship, or accountability, a valuable role performed by financial
reporting. Despite considering the additional discussion of stewardship a positive step,
we continue to view the stewardship role of accounts to be distinct, albeit not
necessarily conflicting, to their decision-usefulness role. We note that the change
compared to the current framework is in fact marginal. While the term “stewardship”
re-appears in paragraph 1.3., this does not entail any more prominent role for
stewardship. In particular, paragraph 1.22 states that stewardship concerns are only
taken into account as far as they overlap with the valuation/decision usefulness focus.
This latter view is highly problematic given that in practice stakeholders need
stewardship information to take decisions which are not directly financial decisions,
such as the decisions of electing directors and of approving financial reports. Why
deprive accounting from assisting decisions of such nature? Further, stewardship
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information helps to motivate good management and prevent opportunistic behaviour
which is a legitimate goal of accounts that deserves separate mention. We would
suggest for example adding to paragraph 2.17, or elsewhere: “The knowledge that
financial information will be reported can also motivate management and prevent
opportunistic behaviour”.
We consider that more research and debate should take place about the decision-
usefulness role of accounts rather than merely how the stewardship role relates to it.
We think that debating more the decision-usefulness role may help resolve issues
related to the stewardship role and the overall purpose financial reports should serve.
Our concerns with decision-usefulness as the primary purpose of financial reporting
relate to two issues which we urge you to seriously consider:
First, we have scant empirical evidence as to how “existing and potential investors,
lenders and other creditors” actually use accounting information to make decisions.
Research by Young (2006) investigates this lack of empirical evidence and the
consequences of this in coming up with a sound rationale for making accounting
policy.2
Second, decision-usefulness suffers from major conceptual weaknesses that you
disregard in the conceptual framework. Williams and Ravenscroft (2015) discuss
some of these weaknesses in relation to decision-usefulness’s unrealistic assumptions
about individual motivation and cognition, and about the predictability of market
behaviour.3
Omiros Georgiou
(b) Do you support the proposals to reintroduce an explicit reference to the notion of
prudence (described as caution when making judgements under conditions of
uncertainty) and to state that prudence is important in achieving neutrality?
The public debate that has recently developed around prudence demonstrates that the
concept has a role to play in financial reporting. We therefore support discussing
prudence in the conceptual framework. We however think that, based on the way you
are re-introducing prudence, it is far from obvious whether, and in what ways,
prudence can provide a practical tool that will help you in developing standards.
In your summary and invitation to comment (page 7) you indicate that part of the
objective of your project is to clarify the role of prudence in financial reporting. It is
difficult for us to see how you achieve this with the re-introduction of prudence. The
only substantial difference to the reference to prudence in the pre-2010 framework is
your attempt to privilege neutrality over prudence. What do you mean by “neutrality
is supported by the exercise of prudence” (para. 2.18)? This statement appears largely
abstract and confusing, especially considering your earlier arguments that prudence
2 Young, J. J. (2006). Making up users. Accounting, Organizations and Society, 31(6), 579-600.
3 Williams, P. F., & Ravenscroft, S. P. (2015). Rethinking decision usefulness. Contemporary Accounting
Research, 32(2), 763-788.
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had to be removed because it was conflicting with neutrality. The discussion in
paragraph BC2.9 does not clarify how prudence can contribute to the neutral
application of accounting policies.
Further, the notions of “overstatement” and “understatement” suffer from a major
logical flaw. Saying that the value of something can be overstated or understated
assumes that a correct value exists out there waiting to be discovered by accounting.
Once this value is calculated exactly, then one has the option to overstate it or
understate it. This clashes with your view that financial reports cannot provide exact
depictions (para. 1.11).
In your earlier deliberations on re-introducing prudence in the conceptual framework
you discussed reframing prudence for both setting standards and for preparing
accounts.4 This was in response to confusion on the part of respondents to your 2013
discussion paper (including Eumedion, Grant Thornton, and ICAEW) as to whether
prudence is a matter that concerns the standard setters or the preparers of accounts and
whether it should be discussed in the conceptual framework. This discussion is not
present in the exposure draft. How are you dealing with this misunderstanding about
the role of prudence which also indicates confusion about the function of the
conceptual framework more generally?
We are of the view that empirical research needs to be undertaken (in terms of how
people, rather than markets, use prudence in practice) in order to develop coherent
argumentation about the role of prudence in financial reporting. You need to explain
further how prudence will help you develop future standards (without going into
standards-level detail). For example, is prudence related to how and when expected
revenue and losses can be recognised and measured? This is what we take from the
reference to prudence in the revised EU accounting directive (article 6). Similarly,
does the warning against the excessive exercise of prudence relate to hidden reserves
and excessive provisions? This is what the pre-2010 framework says (para. 37). These
are issues you may want to clarify.
We find the distinction between cautious and asymmetric prudence to be clarifying
what prudence is not rather than what it is. You may also want to consider discussing
prudence under the heading of measurement uncertainty. It could be argued that
where there is considerable uncertainty, prudence is a way of preventing opportunistic
measurement and catering for the needs of risk-averse users.
We are of the view that your approach to re-introducing prudence suffers from two
main shortcomings:
First, your approach to re-introducing prudence perpetuates the ambiguity that has
grown about the concept. The absence of well-grounded arguments for both the
removal and the re-instatement of prudence reveal the inherent ambiguity of the
concept. Some of the comments made in relation to prudence can be interpreted as
some constituents wanting prudence to simply be there as an overriding virtue
4 IASB. (2014). Prudence, May 2014.
<http://www.ifrs.org/Meetings/MeetingDocs/IASB/2014/May/AP10I-Conceptual%20Framework.pdf> (downloaded 02.09.15).
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expected to govern the behaviour of accountants in undefined ways. In other words,
prudence is similar to saying accounts should be prepared “wisely”. We find the way
you are re-introducing prudence falls victim to the same line of thinking. If the value
of prudence is simply to be mentioned in the conceptual framework, as another
concept among many others, then it is difficult to see how this helps you in your
objective to improve financial reporting that you indicate on page 6 of your summary
and invitation to comment, and to develop standards that better meet the needs of
investors, creditors and other lenders that you indicate on page 8 of your summary
and invitation to comment.
Second, your approach to re-introducing prudence shows that you missed an
opportunity to engage in a productive dialogue with those constituents who oppose
the removal of prudence. Why do some investors object so vehemently the removal of
prudence? Stephen Cooper has written that the objection can be conceived as
“thinking beyond” (page 4) the purpose of preparing accounts as being to provide
relevant information to investors. 5
We are not sure whether this captures the essence
of the objection to the removal of prudence. We are uncomfortable with similar
arguments you make in paragraph BCIN.40 in relation to the role of accounting in
distributions of dividends and bonuses. We were surprised to hear Mary Tokar at the
PD Leake lecture say that the objective of the IFRS Foundation prevents it from
recognising motivational and behavioural purposes of accounting and accountability.
We do not view such purposes to be in conflict with, or out of the remit of, the
objective of “serving capital markets”. The debate that has taken place shows that
there is a need to obtain empirical evidence on issues like what prudence means in
accounting and auditing practice and how prudence relates to the concept of “a true
and fair view” or “fair presentation”. In the absence of such evidence the re-
introduction of prudence appears to be for the sake of silencing opposition to its
removal and/or caving into pressure and threats from the EU in relation to funding
you, rather than, again, improving financial reporting. Georgiou (2015) has researched
this debate and analyses these issues further.6
We concur with Barker’s (2015) analysis that there is a degree of misunderstanding
from both those rejecting prudence and those criticising this rejection.7 We are of the
view that you need to resolve, through obtaining empirical evidence, what prudence
means in practice and what purpose it serves in financial reporting. Only then you will
be able to articulate how prudence can help you develop standards.
Additional comment: the concept of “a true and fair view”
Your decision to remove a reference to the concept of “a true and fair view” is most
likely to lead to further grief to your project. The concept of “a true and fair view” has
been a statutory requirement for UK accounts since 1947 and for the rest of the EU
since 1978. It is also one of the endorsement criteria used by EFRAG. The concept
5 Cooper, S. (2015). Investor perspectives: A tale of ‘prudence’, 11 June.
<http://www.ifrs.org/Investor-resources/Investor-perspectives-2/Documents/Prudence_Investor-Perspective_Conceptual-FW.PDF> (downloaded 02.09.15). 6 Georgiou, O. (2015). The removal and reinstatement of prudence in accounting: How acceptance
politics defeats financialisation. Working paper, University of Manchester. 7 Barker, R. (2015). Conservatism, prudence and the IASB’s conceptual framework. Accounting and
Business Research, 45(4), 514-538.
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has become the subject of judicial interpretation, notably at the European Court of
Justice in cases not directly involving the UK, and, recently, the subject of debates
about the role of financial accounting and auditing in the financial crisis and the
suitability of IFRSs for the EU economy. You refer to “fair presentation” and its
“overriding’ role in IAS 1; and Martin Moore has concluded, in his 2013 opinion, that
these concepts are very similar to those of “a true and fair view” and “true and fair
view override”. Your preference for relevance and faithful representation over “a true
and fair view” in paragraph BC3.44 is unsubstantiated. Despite its unclear role as a
practice, “a true and fair view” has come to represent an exercise of professionalism
by auditors when approving financial statements. Rather than abandoning the concept
from the conceptual framework, a discussion needs to be had about what “a true and
fair view” means in practice. You may be interested in a report commissioned by
ICAS on the concept of “a true and fair view” which will be published in early 2016.8
Omiros Georgiou
(c)Do you support the proposal to state explicitly that a faithful representation
represents the substance of an economic phenomenon instead of merely representing
its legal form?
While substance over form was an explicit component of reliability in the old (pre-
2010) IASB Framework, it was only included implicitly in the definition of reliability
in the FASB’s Concept Statement No. 2. The 2010 Framework followed the FASB
version and did not include substance over form in the main text of the chapter on
qualitative characteristics, while it was stated in the Basis for Conclusions that this
aspect was automatically covered by faithful representation. The IASB now proposes
to give more prominence to substance over form by explicitly including a discussion
of this aspect in ED 2.14. Thereby, as noted in ED BC2.19, the (re)introduction of
substance over form as part of faithful representation only renders it more explicit but
does not reflect any fundamental change. We agree that the explicit reference to
substance over form is useful to corroborate the importance of this concept.
Carsten Erb and Christoph Pelger
(d) Do you support the proposals to clarify that measurement uncertainty is one
factor that can make financial information less relevant, and that there is a trade-off
between the level of measurement uncertainty and other factors that make information
relevant?
Measurement uncertainty is introduced in the ED as a part (or subcomponent) of
relevance and a trade-off relationship is claimed to exist between measurement
uncertainty and “other aspects of relevance” (ED 2.13). The notion of measurement
uncertainty, as drafted in the Exposure Draft, pertains in particular to cases in which
measures are not directly observable but estimates are required (ED 2.12). In the pre-
8 Alexander, D., Costa, M., Georgiou, O., Grottke, M., & Schildbach, T. (2016). What do we know about
the concept of “a true and fair view”? ICAS, Forthcoming.
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2010 framework relevance and reliability were separate characteristics which were
also claimed to be in a trade-off. Our comments relate to three points:
1) The concept of measurement uncertainty;
2) The placement of measurement uncertainty under the concept of relevance and
the notion of a trade-off;
3) The link to other qualitative characteristics, in particular verifiability.
First, we understand that the introduction of measurement uncertainty is a response to
constituents’ criticism on the replacement of reliability in the 2010 framework. ED
BC 2.22 implies that measurement uncertainty is supposed to reflect what constituents
often associated with reliability in the pre-2010 framework. Research has analysed
reliability’s history as a concept in standard-setting and found marked differences
between its use in academic and standard-setting discourses and its use in accounting
practice.9 In particular, practitioners’ understanding of reliability has been linked to a
traditional notion of objectivity/verifiability, which is often associated with the
availability of evidence. In more recent times, when fair value accounting rose in
importance, reliability was often used by constituents to argue against the introduction
of such measurement, referring in particular to the “unreliability” of estimated (level 2
or 3) fair values. Thus, we concur that measurement uncertainty captures the meaning
many constituents have traditionally associated with reliability.
Although reliability as a common language word is still likely to be used in
accounting discussions, we observe that the IASB does not intend to go back to the
term “reliability” because of the different meanings that have been attached to this
term and the fact that faithful representation is presented as the formal successor to
reliability. We think that the choice of the new term, measurement uncertainty, is
appropriate in light of constituents’ concerns and entails the potential to improve the
boards’ reasoning in the conceptual framework and future standard-setting projects.
The IASB, however, might want to reflect if (or how) other aspects of uncertainty that
are dealt with in accounting standards (e.g. existence uncertainty) are related to the
concept of measurement uncertainty.
Second, the IASB proposes to include measurement uncertainty as part of relevance.
We understand the reasoning in ED 2.13 that higher degrees of measurement
uncertainty might ceteris paribus lead to less relevant information than lower degrees
of uncertainty. Intended or not, the IASB’s proposal corresponds to recent
experimental research in accounting which revealed that issues of reliability
(understood as measurement uncertainty) often form part of a decision-makers’
judgement of the relevance of a piece of information.10
However, in our view the
placement needs more elaboration, in particular because in the pre-2010 framework
relevance and reliability were treated as separate and opposing characteristics.
Encompassing measurement uncertainty in relevance may at first sight appear
counterintuitive and therefore we see the need for further arguments why this concept
is appropriately placed as part of relevance.
9 cf. Erb & Pelger, 2015, Accounting, Organizations and Society 2015, Vol. 40, Issue 1, pp. 13-40
10 Kadous/Koonce/Thayer, The Accounting Review 2012, Vol. 87, Issue 4, pp. 1335-1356
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Relatedly, the IASB reintroduces the trade-off relationship which is now said to exist
between measurement uncertainty and other aspects of relevance. The consideration
of a trade-off has been central to accounting discourses and has shaped thinking about
accounting problems for decades. We thus think that reintroducing the trade-off is a
useful step which we believe has considerably strengthened the conceptual
discussions in other parts of the Exposure Draft (e.g. ED 5.13, ED 6.55). The trade-off
enables the IASB to reflect more consistently and understandably on issues regarding
recognition and measurement. However, we again note that more arguments need to
be provided why it makes sense to encompass this trade-off within the concept of
relevance. For example, it should be discussed further how precisely the “other
aspects of relevance” might be opposed to measurement uncertainty.
Third, and related to the first point, it is not clear to us why verifiability is not
encompassed in the notion of measurement uncertainty or why no explicit link
between these concepts is mentioned. As noted above, constituents have traditionally
associated reliability with concerns of objectivity and verifiability. Verifiability has
been positioned as an enhancing qualitative characteristic in the 2010 framework.
Although ED 2.29 defines verifiability as different knowledgeable and independent
observers reaching consensus as to a depiction being a faithful representation, its
further description underlines verifiability’s proximity to the idea of ensuring low
levels of measurement uncertainty. For example, ED 2.30 describes direct verification
as the process of checking an amount through observation, i.e., minimizing
measurement uncertainty. Also, ED 2.31 directly refers to forward-looking
information which often requires estimates. The definition of verifiability is not
identical, though in our view closely related to concerns of measurement uncertainty.
Thus, we would suggest that the IASB includes verifiability concerns in the concept
of measurement uncertainty.
Carsten Erb and Christoph Pelger
(e) Do you support the proposal to continue to identify relevance and faithful
representation as the two fundamental qualitative characteristics of useful financial
information?
We generally agree that relevance and faithful representation are major qualitative
characteristics. However, in our view it would seem more consistent to set up three
fundamental qualitative characteristics: Relevance, faithful representation and
measurement uncertainty. This solution would capture all aspects of the former
concept of reliability from the pre-2010 framework and at the same time establish a
clear distinction between separate characteristics to avoid the confusion which
surrounded the pre-2010 framework concept of reliability.
Carsten Erb and Christoph Pelger
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Pauline Weetman
Edinburgh University
Chapter 3 – Financial statements and the reporting entity
This chapter is headed “Financial statements and the reporting entity”, but is
confusing in serving three separate purposes. The IASB question 2 relates only to the
third purpose of delineating reporting entities.
The first purpose is found in paragraph 3.2-3.9: to define financial statements in
outline, but refers the reader to Chapters 4, 5, 6 and 7 for further information. This
section seems to constitute an introduction as if the conceptual framework was
starting again at Chapter 3. If these paragraphs are guides to subsequent chapters it
would seem more logical to put them at the start of the Conceptual Framework as part
of an introduction.
The second purpose is to give a location for the going concern assumption (para.
3.10). This seems to be a paragraph that has no natural home in any other chapter and
sits here alone with no indication in the chapter title that we might expect to find it
here. There is a significant change of wording in paragraph 3.10, which states that
“This Conceptual Framework is based on the assumption….” Previously the wording
was: “The financial statements are normally prepared on the assumption…” There is
no explanation in the Basis for Conclusions (BC 3.4) as to why this change has been
made. It seems rather strange to make a statement about the basis of the entire
Conceptual Framework in a section of Chapter 3 which is headed as referring only to
financial statements.
The third purpose of the chapter is to describe the reporting entity, which was the only
aim previously. An exposure draft has previously been issued for comment.
Answers to specific questions
Question 2—Description and boundary of a reporting entity
Do you agree with:
(a) the proposed description of a reporting entity in paragraphs 3.11–
3.12; and
(b) the discussion of the boundary of a reporting entity in paragraphs
3.13–3.25?
Why or why not?
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We agree with the descriptions and discussion. BC 3.9 explains that respondents on
the previous exposure draft asked for clarification of choice and requirement in
relation to general purpose financial statements. This is now given in paragraphs 3.11-
3.12. BC 3.10 explains that the boundary is determined by control. Paragraphs 3.13-
3.25 give clear explanations of how direct and indirect control can lead to
unconsolidated and consolidated financial statements. There is sufficient outline
guidance here to establish principles, leaving greater detail to the standards.
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Mike Page
Portsmouth University
Chapter 4 – The elements of financial statements Answers to specific questions
Question 3—Definitions of elements
Do you agree with the proposed definitions of elements (excluding issues relating to
the distinction between liabilities and equity):
(a) an asset, and the related definition of an economic resource;
(b) a liability;
(c) equity;
(d) income; and
(e) expenses?
Why or why not? If you disagree with the proposed definitions, what
alternative definitions do you suggest and why?
We are broadly supportive of the definitions of assets and liabilities subject to
reinstating the rider “or other source of value” or similar. We believe the definitions
of the other elements contain category errors because they involve a mixture of
different kinds of concept. (See below for elaboration)
Question 4—Present obligation
Do you agree with the proposed description of a present obligation and the proposed
guidance to support that description? Why or why not?
We support the description of a present obligation although it will (continue to)
require considerable sophistry to argue that deferred tax is a liability under this
criterion.
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Question 5—Other guidance on the elements
Do you have any comments on the proposed guidance? Do you believe that additional
guidance is needed? If so, please specify what that guidance should include.
In our response to the discussion paper (DP) we supported the revised definition of
assets proposed there. The ED proposes to delete the words “other source of value”
from the characterisation of economic benefits proposed in the DP. The discussion of
rights in the ED then involves an extension of the meaning of rights to much the same
effect. It would be better to leave the word “right” to mean what it is commonly
understood to mean and to add a rider such as “other source of value” or “access” to
encompass the extensions to the meaning of rights.
“Economic benefits” remains an undefined term in the conceptual framework (there
have to be some otherwise there is an infinite regress of definitions). Instead, the term
is characterised by examples with the effect that economic benefits are made up of
other economic benefits. The characterisation is thus circular. To break out of the
circle, either some economic benefit needs to be privileged – eg) cash could be
designated as both an economic benefit and a right to an economic benefit – or there
needs to be acknowledgement that economic benefits must at some point be turned
into welfare benefits enjoyed by humans.
We welcome the attempt to separate definition, recognition and measurement of
elements. However, the ED has been only partially successful in this. What does it
mean to say the equity is the residual interest in the assets after deducting all the
liabilities? This is an apples and oranges problem because the diverse rights that
constitute assets may be incommensurable with the obligations that constitute
liabilities. What does it mean to “deduct” the obligation to pay a creditor from the
rights embodied in a motor car? Only when both items have been measured in
common units does it become possible to deduct one from the other. Even referring to
a residual doesn’t help, since, to do so assumes paying off the liabilities and realising
the assets, which violates the going concern assumption.
The same problem arises in the definitions of income and expenses. Income is defined
as an increase in economic benefits in the form of inflows of assets etc. Elsewhere the
ED has been at some pains to distinguish rights to economic benefits from economic
benefits. An inflow of assets is an inflow of rights to economic benefits. Where assets
have changed form it may not be possible to tell whether an increase has taken place
until measurement has occurred, so that the definition of income and expense is
implicitly dependent on recognition and measurement procedures.
The same reasoning applies to the definition of expenses.
Remedies
The ontological question of what equity is could be avoided by simply describing it as
the proprietorship (not “ownership”) interest in the business and deferring
measurement to Chapter 6. It is not clear what is gained by having separate definitions
for income and expense. As currently defined they are artefacts of the measurement
process. It would be better to defer definition to Chapter 6.
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Mike Page
Portsmouth University
Chapter 5 – Recognition and derecognition
Answers to specific questions
Question 6—Recognition criteria
Do you agree with the proposed approach to recognition? Why or why not? If you do
not agree, what changes do you suggest and why?
The proposed approach to recognition represents an improvement on the status quo.
In relation to measurement uncertainty (5.20 and 5.21), prudent historical cost
measurements are generally available and can be used in many circumstances, with
related disclosures, but they may not work for highly uncertain liabilities with low
probability but high value outcomes.
Question 7—Derecognition
Do you agree with the proposed discussion of derecognition? Why or why not? If you
do not agree, what changes do you suggest and why?
The balanced approach to control vs risk and reward is supported. Individual
standards can deal with particular cases. Accounting for the substance of transactions
should resolve some difficult cases.
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Omiros Georgiou
Manchester University
Geoff Whittington
Cambridge University
Chapter 6 – Measurement
Answers to specific questions
Question 8—Measurement bases
Has the IASB:
(a) Correctly identified the measurement bases that should be described in the
Conceptual Framework? If not, which measurement bases would you include
and why?
(b) Properly described the information provided by each of the measurement
bases, and their advantages and disadvantages? If not, how would you
describe the information provided by each measurement basis, and its
advantages and disadvantages?
The measurement bases have not been identified correctly. As indicated in our
response to the Discussion Paper, current value should embrace more alternatives and
these should be sub-divided into “entry” and “exit” values. Relevant entry values are
replacement cost and deprival value (in addition to historical cost, which is an entry
value assessed historically). Exit values should include value in use and net realisable
value, in addition to fair value. The reason given for ignoring the exit/entry distinction
(BC 6.18) is based on the irrelevant assertion that the two values will differ little in
the same market, but the “which market?” problem is common, as can be seen in the
IASB’s struggles to avoid “Day 1” profits in areas such as insurance and long-term
contracts: such profits arise from switching from entry to exit prices (typically in
different markets).
The most significant addition required is a full consideration of current entry values.
These are particularly relevant to assessing the value of real (as opposed to monetary)
assets. Both replacement cost and deprival value have an extensive literature and have
been applied in practice.
In terms of the IASB’s proposed framework for choosing the measurement basis
according to the item’s contribution to future economic returns, replacement cost is
particularly relevant to measuring costs in the performance statement. It gives a
current measure of the cost of resources consumed and may thus be highly relevant in
assessing the profit margins achieved. It is, for example, used in this way by leading
oil companies such as BP, who adjust the cost of crude oil consumed to replacement
cost and claim that this is more informative than historical cost. Moreover, the
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replacement cost of an asset held for use gives an indication in the balance sheet of
the current value of the resources held for future use: if they were not already held,
the entity would have to purchase supplies at replacement cost, and this future cost
saving is the economic benefit attaching to the asset. Replacement cost does not
preclude retaining historical cost, which can be included in the same reports as
replacement cost by including a separate disclosure of the “holding gain” (or loss)
that reconciles the two.
Deprival value addresses the problem that replacement cost may not be a relevant
measure when replacement is not justified. It therefore substitutes the recoverable
amount (i.e. the higher of net realisable value or value in use) when it is lower than
replacement cost. This is an impairment test (using recoverable amount as the
impaired value) and we can interpret deprival value as the current value equivalent of
the traditional historical cost with impairment testing. A more sophisticated
interpretation of deprival value, grounded in economic theory, is that it represents the
current value of the economic benefits attaching to the asset (or, in the case of its
counterpart for liabilities, relief value, the economic obligations), based upon a
rational choice between the alternative economic opportunities open to the business.
This appears to be entirely consistent with the IASB’s current criteria for choosing
between valuation bases, and it is unfortunate that the IASB appears to be unaware
that deprival value offers a systematic method, well grounded in theory, for choosing
between alternative current values. The reasons given (BC 6.18 (c)) for ignoring
deprival value are that it is “complex” and that it is “not well accepted in some
jurisdictions”. Both of these criticisms apply equally to fair value, which is given very
full treatment in the ED.
Current cost is not clearly defined in the ED. It is usually associated with the use of
deprival value or a simplified version of it. The ED should clarify the meaning of
current cost in 6.18, where it appears to be equated with replacement cost. Also, the
ED should provide a better reason for rejecting current cost than the extraordinary
statement (BC 6.23) that it will not be considered further because the IASB does not
anticipate using it. Surely the Framework is supposed to guide future decisions, rather
than assuming that they have already been made.
With regard to exit values, the treatment of value in use is satisfactory, the treatment
of fair value is potentially misleading, and the treatment of net realisable value is
inadequate.
Net realisable value, which is characterised in the ED as fair value less cost to sell,
has a stronger rationale than fair value. It represents (if reliably or “faithfully”
measured) one economic opportunity that is available to the entity owning it: disposal
through the market. Fair value, on the other hand, does not measure a real economic
opportunity because it ignores the transaction costs of selling, which are an
unavoidable consequence of realising the sale price (fair value). These costs can be
substantial, especially in markets for non-financial assets. The ED is an improvement
on the DP in its more thorough discussion of transaction costs, but it has a blind spot
in its treatment of selling costs in relation to fair value (6.26 and BC6.35 (b)), in that it
fails to recognise that these costs need to be deducted from selling price if the fair
value measure is to fulfil the stated objective of capturing potential future
contributions to cash flows.
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Apart from the failure to consider selling costs, the discussion of fair value (6.21-
6.33) appears to make excessive claims for the relative merits of fair value. The
properties described in 6.22-6.25 are properties of any market prices (entry or exit) set
in a perfectly competitive market. Moreover, fair value will not necessarily represent
these factors faithfully. The problem, which applies in some degree to all of the
alternative current value measures, is that perfect (or near-perfect) market prices are
often unavailable so that a measurement method relies on proxies: hence the extensive
guidance on model-based estimates in IFRS 13. Therefore, it should be made clear
that:
(a) Fair value is not unique in reflecting, or attempting to reflect, the factors listed
in 6.21-6.33.
(b) The extent to which fair value reflects those factors faithfully depends upon
the circumstances and the information available, particularly the availability of
prices from competitive market prices.
The claim made in 6.28, that fair value has predictive value, is questionable. Fair
value is based on the expectations of market participants rather than the business that
is using the asset; and the expectations of the operator, as incorporated in value in use
(with entity specific assumptions) would be expected to give a more informed view of
expected future returns.
Question 9—Factors to consider when selecting a measurement basis
Has the IASB correctly identified the factors to consider when setting a measurement
base? If not, what factors would you consider and why?
The ED is correct to use the criteria laid down elsewhere in the Framework to guide
the choice of measurement methods. Relevance (6.53-6.56) is obviously a critical
criterion for deciding which measures give the most useful information and 6.54
correctly asserts that this will be determined by how the asset contributes to the
business of the entity. However, this should not be framed (as in 6.54 (a) and (b)) in
terms of contribution to future cash flows. The preferable wording would refer to
economic benefits rather than cash flows. This would be consistent with the ED’s
definitions of assets and liabilities (Chapter 4), which refer to economic benefits
rather than cash flows, and would avoid the potential confusion that cash flows can be
interpreted narrowly to include only cash transactions. In fact, the future economic
benefits from assets held for use in the business consist of future services: these will
have a cash value (such as expenditure avoided as a result of owning the resources
used), but that will not necessarily be reflected directly in a cash receipt.
The principle stated in 6.54, that the asset’s contribution to the entity should
determine measurement, appears to contradict the statement in 6.44 that fair value (a
non-entity specific measure) yields greater comparability. Unless markets are perfect,
the unique opportunities available to the specific firm should determine the
measurement of the economic benefits that it can derive from its assets, so that
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acceptance of 6.54 makes fair value an inappropriate measure which imposes the
appearance of similarity on different circumstances. Fair value thus suppresses true
comparability, which should reflect real differences rather than imposing artificial
uniformity.
Question 10—More than one relevant measurement basis
Do you agree with the approach discussed in paragraphs 6.74-6.77 and BC 6.68?
Why or why not?
The approach described in 6.74-6.77 is acceptable because it provides a “clean
surplus” statement of comprehensive income, reconciling changes in the statement of
financial position to the profit and loss account, thus avoiding the potential lack of
transparency that might arise from using different measurement methods for the same
items in different statements.
Additional comment
There is evidence that contradicts the alternative view by Patrick Finnegan that
financial statement analysis would be easier for users if all assets and liabilities were
measured using current value measures (para. AV27). This has traditionally been the
view of officials of the CFA Institute but many investment professionals using
accounting in financial analysis have expressed a clear preference for a mixed
measurement model. Some examples include contributions by CRUF, views
expressed in IASB-CMAC meetings, and contributions by financial analysts at the
yearly ICAEW Information for Better Markets Conference (see for example Anderson
(2014)).11
See also research by Cascino et al. (2013), Gassen and Schwedler (2008),
and Georgiou and Jack (2015) on this issue.12
11
Anderson, N. 2014. Discussion of: ‘Performance measurement: an investor's perspective’.
Accounting and Business Research 44 (4): 407-409. 12
Cascino, S., Clatworthy, M., García Osma, B., Gassen, J., Imam, S., & Jeanjean, T. (2013). The use
of information by capital providers. The European Financial Reporting Advisory Group (EFRAG) and
The Institute of Chartered Accountants of Scotland (ICAS).
Gassen, J., and K. Schwedler. (2008). Survey: the view of European professional investors and their
advisors. Attitudes towards fair value and other measurement concepts: an evaluation of their
decision-usefulness. Accounting Standards Committee of Germany (ASCG), Humboldt-Universität zu
Berlin, and The European Federation of Financial Analysts Societies (EFFAS).
Georgiou, O., & Jack, L. (2015). Evaluating fair values: Dissonance and the worth of financial
accounting. Working paper, London School of Economics.
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Ioannis Tsalavoutas
Glasgow University
Chapter 7 – Presentation and Disclosure
Answers to specific questions
Question 11— Objective and scope of financial statements and communication
Do you have any comments on the discussion of the objective and scope of financial
statements, and on the use of presentation and disclosure as communication tools?
In general, we agree with the proposals included in the ED on the objective and scope
of financial statements although we take issue with the ED not identifying the ones
that are primary nor proposing separate objectives for the individual statements within
the financial statements or notes thereto (BC7.5). The IASB considers that such
definitions and objectives are best considered in the Performance Reporting project
and the Disclosure Initiative.
BC7.6 also states that the IASB considers that setting out an objective for the
financial statements as a whole would clarify their scope and, hence, clarify the
boundary between financial statements and other forms of financial reports, such as
management commentary. Although we agree that establishing a clear boundary
between financial statements and other forms of financial reports, such as
management commentary, would enhance the usefulness of the Framework, it is
unclear why a clear boundary should not also be drawn between the primary financial
statements and the notes.
It is unclear why these issues have to be dealt separately from the Conceptual
Framework. Does this not involve the risk of having to revise the Conceptual
Framework upon completion of the Disclosure Initiative project?
Throughout the ED, the words “presentation and disclosure” are used as having the
same meaning or resulting in one common/combined outcome. It would be preferable
if a distinction between ‘presentation’ and ‘disclosure’ were provided.
Paragraph 7.8 inter alia states: “Efficient and effective communication includes: …
using presentation and disclosure objectives and principles instead of rules that could
lead to purely mechanistic compliance.” If the objective of the IASB is to implement
this approach, the term “disclosure requirements” should be avoided in the individual
accounting standards to avoid undermining the aspiration underlying this statement.
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Question 12 – Description of the statement of profit or loss
Do you support the proposed description of the statement of profit or loss? Why or
why not?
If you think that the Conceptual Framework should provide a definition of profit or
loss, please explain why it is necessary and provide your suggestion for that
definition.
Although we welcome the description of the statement of profit or loss proposed in
the ED, we are of the view that a description of the notion of “return on an entity’s
economic resources” would be necessary. Currently, this is open to various
interpretations, leading potentially to significant variations in financial reporting
practices.
More generally, the concepts of “profit”, “return” and “performance” are not defined
explicitly in the ED. Lack of an understanding of how these concepts are
perceived/defined does not allow for commenting adequately on Questions 13 and 14.
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Pauline Weetman
Edinburgh University
Chapter 8 – Concepts of capital and capital maintenance
Paragraph BC8.1 informs the reader that the material in Chapter 8 is carried forward
unchanged from the existing Conceptual Framework except for a limited number of
editorial changes (see paragraph BCIN.24). However paragraph BCIN.24 notes that
current cost is not discussed in detail as a possible basis for measurement (as justified
in para BC 6.23) The failure to discuss current cost measurement places a major
constraint on Chapter 8 so that even although the words remain unchanged, their
significance is severely diminished. We express our concern about current cost
measurement in our response to Question 8.
In our response to the Discussion Paper we expressed concern about the failure to
consider revision of Chapter 8. In particular we pointed out that equating capital
maintenance to high inflation dismissed at a stroke all that has been written in
accounting theory on concepts of income and concepts of capital maintenance. We
commented:
“Paragraph 4.65 of the existing Conceptual Framework states: ‘At the present time, it
is not the intention of the Board to prescribe a particular model other than in
exceptional circumstances, such as for those entities reporting in the currency of a
hyperinflationary economy.’ The wording of paragraph 9.49 of the Discussion Paper
implies that the IASB sees the exceptional circumstances of hyperinflation as the only
case for acknowledging the existence of the concept of capital maintenance.’
We also provided reference to academic authority on the subject.
It is disappointing to see that the IASB persists in this wording in what is now
paragraph 8.9. The equating of capital maintenance with high inflation clearly
persists in the mind of the IASB. On page 18 of the Exposure Draft, under the
heading Chapter 8, it is stated:
“The existing discussion of capital maintenance is included in this Exposure Draft
substantially unchanged from the existing Conceptual Framework. The IASB would
consider revising the Conceptual Framework discussion of capital maintenance if it
were to carry out future work on accounting for high inflation. No such work is
currently planned (see paragraphs BCIN.24 and BC8.1).”