WHAT REALLY MATTERS FOR INCOME PRESENTATION?

FORMAT VARIATIONS VS COHERENCE CONCERNS

ABSTRACT

Purpose This paper focuses on the incoherence concerns relating to the reporting of holding gains and losses, to elucidate how these can be rendered more coherent and meaningful. Design On the basis of the Coherence Theory of Truth we discuss the incoherence of the IASB system, and highlight the possible contribution of the more coherent theoretical underpinnings of Economia Aziendale.Findings The IASB and Economia Aziendale share a common focus on desiring clean surplus accounting and maintenance of the long-run operating capability. If the IASB would include in its system the founding notions of Economia Aziendale it could fully realise clean surplus accounting, better satisfying the needs of different users.Value Economia Aziendale could contribute to the improvement of the current IASB accounting system, rel-evant for academicians and practitioners, and in general for policy makers, local standard setters and coun -tries presenting similar characteristics to Italy.

Article classification: Conceptual paperKeywords: Coherence, Economia Aziendale, Conceptual Framework, IFRS.

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1. INTRODUCTION

The International Accounting Standards Board (IASB) has long been involved in reviewing the reporting

format of performance, since 1996, when the former International Accounting Standard Committee (IASC)

issued ED 53 Proposed International Accounting Standard – Presentation of Financial Statements. One of

the aims of this ED was to focus attention on the issues relating to the appropriate reporting for holding gains

and losses. However, seventeen years have passed, there have been a number of amendments to the reporting

format of performance, but agreement has not yet been reached, thus leading to still on-going projects and

related debate to attain a ‘conceptually robust’ accounting standard on the presentation of financial

statements. The result is that holding gains and losses are still being treated inconsistently in the financial

statements and the IASB is still looking for an appropriate place for them.

Yet in 2003 Newberry suggested that such conceptual robustness was difficult to accomplish because of the

incoherence of the Conceptual Framework (CF), which is also related to the long-standing and still unsettled

battle over concepts of income (Barker, 2004). More recently, Cooper (2007) stressed that there is little

conceptual logic behind most of the current classifications and methods of presentation, and that this has an

undeniable impact also on other projects of the IASB, because it is difficult to solve the other accounting

problems without a suitable means to meaningfully present the related gains and losses. Also, other parties

(e.g. companies, auditors, regulators, domestic standard setters) in response to the ED Presentation of

Financial Statements: a Revised Presentation (2006) and ED Presentation of Items of Other Comprehensive

Income (2010) have emphasised the need for a stronger theoretical foundation for the concept of

comprehensive income, currently lacking within the CF. In this regard, Hans Hoogervorst, Chairman of the

IASB, has recently recognised (2012) the need for clarifying the basis upon which different gains and losses

are reported in different ways, and that in the on-going review of the CF the IASB will try to make income

presentation more meaningful.

It is worth noting that the current IASB’s Conceptual Framework (2010) is capital-providers based and thus

oriented towards a decision-usefulness approach. However, the IASB itself recognises that there are also

particular subsets of primary users of financial reports other than capital-providers. Hence, the decision-

usefulness of financial information should attain the needs of different kinds of users. As Whittington (2008)

states essential characteristics of information to ensure decision-usefulness are the relevance and the faithful

representation of the real-world economic phenomena that it purports to represent. In this respect, Alexander

and Archer (2003) specify that the proper understanding of representational faithfulness is related to the

preliminary comprehension of the concepts of reality and truth in the context of financial reporting and

emphasise the possible relevance of a Coherence Theory of Truth (CT) in explicating the relationship

between accounting and its objects. Drawing on Alexander and Archer (2003), in this research we assume

that a conditio sine qua non for the fulfilment of decision-usefulness is the coherence of the information

provided in financial reports. Coherence, in turn, implies that accounting standards have to be consistent with

the Conceptual Framework and the Conceptual Framework has to be consistent with itself. Accordingly, this

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paper examines the reporting of holding gains and losses, by focusing on the claimed incoherence concerns

related to the lack of conceptual bases.

In particular, for the purposes of this research, and in line with Newberry (2003), we refer to a traditional

accounting theoretical approach. Specifically, we use the traditional Italian normative entity theory

(Economia Aziendale, see e.g., Viganò, 1998; Zambon and Zan, 2000; Capalbo and Clarke, 2006; Viganò

and Mattessich, 2007). Economia Aziendale is characterised by the importance of a unitary and coordinated

view of the entity, which should be analysed from the three perspectives of management, organization and

accounting to take into account the interdependences between all the operations. The main Economia

Aziendale principles allow the provision of coherent theoretical underpinnings, which subsequently are

helpful to provide coherent information in financial statements, that is useful for different kinds of users with

various information needs. In this regard, what should be clarified is that we mainly refer to the theoretical

accounting conceptions pursued by Economia Aziendale, rather than focusing on the Italian accounting

practices. Indeed, although the theory has influenced in many ways the accounting practices, as Alexander

and Servalli (2011) argue, these over the years have been affected also by other variables (e.g. law,

regulation, taxation, legal profession practices).

A further essential element that justifies the reference to Economia Aziendale is related to the awareness that

IFRS are widely used around the world, by countries presenting similar characteristics to Italy. These

countries are indeed characterised by a manufacturing, retail and service tradition, with a vast majority of

entities that are business-oriented rather than financial market-oriented (Hoogervorst, 2012). This clearly

results in an increasing need for taking into account the real productive nature of such entities, rather than

focusing only on financial orientation.

The remainder of the paper is structured as follows. Section 2 briefly examines the conception of coherence

that we refer to. Section 3 discusses the issues of incoherence in the IASB treatment of comprehensive

income. Section 4 describes the main characteristics of the coherent approach of Economia Aziendale.

Section 5 highlights a possible way forward through the contribution of the Economia Aziendale. Section 6

analyses recent developments from IASB and EFRAG on the CF revision project, and Section 7 provides

concluding remarks.

2. THE COHERENCE THEORY OF TRUTH IN ACCOUNTING

In this section we attempt to depict the conception of coherence that we refer to, in view of the fact that this

represents a conditio sine qua non for the fulfilment of the information usefulness of financial reporting.

Alexander and Archer (2003) emphasise that to be useful information must be relevant and faithfully

represent what it purports to present, also suggesting that the proper understanding of representational

faithfulness is related to the preliminary comprehension of the concepts of reality and truth in the context of

financial reporting. In focusing on the concept of truth, the authors have devoted attention to the contrast

between two different ‘definitions of truth’ in financial reporting. More precisely, they highlight that a

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particular view of truth, which they term Correspondence Theory of Truth (CTT), has been assumed by

accounting standard setters. However, they contend that CTT is problematic in the context of accounting,

thus proposing alternative theories of truth more helpful in explicating the relationship between accounting

and its objects. Hence, they emphasise the possible relevance of a Coherence Theory of Truth (CT).

The coherence theory differs from its principal competitor, the correspondence theory of truth, in two

essential respects, in that the competing theories give conflicting accounts of the relation between

propositions and their truth conditions. The former states that the relation between propositions is coherence;

on the contrary according to the latter the relation is correspondence. Moreover, according to the CT, the

truth conditions of propositions consist in other propositions. The CTT, in contrast, states that the truth

conditions of propositions are not (in general) propositions, but rather objective features of the world.

Consequently, the criticism against CTT arises with regard to the fact that a belief cannot be true because it

corresponds to something which is not a belief. Instead, the truth of a belief can only consist in its coherence

with other beliefs, i.e. a belief is ‘true’ only to the degree that it coheres with other beliefs.

Given the above discussion, the argument which supports Alexander and Archer’s (2003) view is that CTT

implies an objectified conception of economic reality, termed external realism (ER), based on the notion of

the world as constituted of some fixed totality of mind-independent objects. However, the authors, in line

with Searle (1995), reject ER as a valuable ontological basis for accounting, in favor of an internalist

perspective, termed internal realism (IR). In fact, according to the latter, accounting objects do not exist

independently of a conceptual scheme that relates accounting concepts to each other and to their empirical

referents (Alexander and Archer, 2003). Consequently, switching from ER to IR (incompatible with CTT)

forces the adoption of a different theory of truth, such as CT.

In this regard, it is also worth noting that the aversion against the CTT in favor of CT, although with various

nuances and in several cases not explicit, is common also to other authors such as Shapiro (1997), Mattessich

(2003) and Lee (2006). Subsequently, in accordance with these views, we provide here a basic and general

formulation of the CT, by also discussing its implications for accounting in general. In particular, drawing on

Dorsey (2006), who describes the CT in ethics, we summarise the main characteristics of his formal model.

In the following sections this will be recalled as a guideline to run our discussion on the incoherence of the

IASB accounting system, and to highlight the possible contribution of the Economia Aziendale, as a coherent

accounting framework.

In his study Dorsey gradually examines the concepts of truth and coherence, providing a progressive

formulation of these two by discussing the main implications of the related choices, and also examining the

possible objections that arise against the model. The author addresses the examination of the concepts

starting from a preliminary definition of truth, as follows:

T1: a normative sentence x is true if and only if it is part of a normative system and that system is coherent.

He clarifies that this formulation is not satisfactory, and emphasises that there is the need for relativizing

truth to a system as follows:

T2: A normative sentence x is true in a normative system L if and only if x is part of L and L is coherent.

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Also this formulation is not completely satisfactory given that it implies that the relativization of truth is nec-

essary, but not sufficient. Indeed, if we accept T2 when the normative system is incoherent, any normative

sentence is false. However, this problem can be avoided because even though a system is not coherent, if it is

reasonable to think that a sentence x would be part of a system adjusted, expanded and rid of incoherence -

through the Quinean doctrine of minimal mutilation - then it is true. Hence, Dorsey specifies that if there are

a number of sentences held with confidence, these are regarded as the center of the web of belief and inco -

herent systems are revised in the light of these sentences in so far as is possible. Accordingly:

T3: A normative sentence x is true in a system L if and only if either x is a member of L and L is coherent, or

x is a member of L* where L made coherent according to the Quinean doctrine of minimal mutilation yields

L*.

At this point of his analysis Dorsey specifies that, although T3 is a good starting point, there is the need for

enhancing the model by clearly characterizing coherence. Thus, drawing on Kirkham (1992), preliminary

coherence is defined as follows:

«The term “coherence” as used by coherence theories has never been very precisely defined. The most we

can say by way of general definition is that a set of two or more beliefs are said to cohere if and only if (1)

each member of the set is consistent with any subset of the others and (2) each is implied (inductively if not

deductively) by all of the others taken as premises or, according to some coherence theories, each is implied

by each of the others individually».

In this regard, Dorsey further specifies that coherence alone is not sufficient because some relationships of

mutual implication between the sentences are required. Therefore a second constraint to satisfy is the

derivability (which also requires the use of non-normative sentences and that is satisfied if a sentence is

derivable from all other sentences taken together).

Accordingly coherence can be formalised as follows:

C1: A normative system L is coherent if and only if, for all normative sentences x, if x is a member of L, x is

consistent with all other sentences of L and is derivable by a system of deductive logic with all other sen -

tences of L and any requisite non-normative sentences available as premises.

Furthermore, at this stage it is worth clarifying that a number of general normative principles are not always

derivable via a system of deductive logic, thus an account of inductive generalization should be included.

Also, there is the need to clarify clearly which is the relevant set of implications. Consequently:

C2: A normative system L is coherent if and only if, for all normative sentences x, if x is a member of L, x is

consistent with all other members of L and their normative implications and is derivable by a system of de-

ductive logic or inductive generalization with all other sentences of L and any requisite non-normative prin-

ciples available as premises.

So, finally, the author takes T3 as the relevant truth predicate, wherein coherence is defined as above (C2).

At this point a clarification is due: indeed, along his study Dorsey highlights that at a first glance three main

objections related to derivability, circularity and mixed inferences can be moved against the model designed.

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However, he also contends that such objections are in reality problems without strong foundation, or at least

eliminable, thus corroborating the correctness and usefulness of the proposed model.

Accordingly, in the next sections we employ Dorsey’s model as a guideline for the discussion, assuming T3

as the relevant truth predicate, wherein coherence is defined as above (C2).

3. THE “INCOHERENCIES” INSIDE THE CONCEPTUAL FRAMEWORK AND BETWEEN THE

CONCEPTUAL FRAMEWORK AND IFRS IN RELATION TO THE REPORTING OF HOLDING

GAINS AND LOSSES

This section aims at clarifying what are the elements of incoherence inside the IASB CF and between IFRS

and the CF in relation to the reporting of holding gains and losses, through the lens of the model shown in

the previous section. The issues related to the reporting of holding gains and losses involve the consideration

of the matters associated with the measurement of profit (or loss). Hence, we will start our reasoning by

mainly referring to the concept of profit, which is explicated in the CF, as follows:

“Profit is frequently used as a measure of performance or as the basis for other measures, such as return on

investment or earnings per share. The elements directly related to the measurement of profit are income and

expenses. The recognition and measurement of income and expenses, and hence profit, depends in part on

the concepts of capital and capital maintenance used by the entity in preparing its financial statements” (CF,

§ 4.24, 2010).

The IASB clarifies that the key elements to take into account for measuring profit are: the criteria for the re -

cognition of income and expenses and the concepts of capital and capital maintenance. Thus, for the purpose

of clarity, in the subsequent table we briefly summarise the main aspects of these concepts, but to develop

our discussion we will also refer to the extensive explanation of these within the CF.

Table 1 – Key elements for measuring profit under the IASB Conceptual Framework

Recognition of the elements of financial statements (§ 4.38)

An item that meets the definition of an element should be recognised if:(a) it is probable that any future economic benefit associated with the item will flow to or from the entity; and(b) the item has a cost or value that can be measured with reliability.

Capital (§ 4.57)

Under a financial concept of capital, such as invested money or invested purchasing power, capital is synonymous with the net assets or equity of the entity.Under a physical concept of capital, such as operating capability, capital is regarded as the productive capacity of the entity based on, for example, units of output per day.

Capital maintenance

(§ 4.59)

Financial capital maintenance. Profit is earned only if the financial (or money) amount of the net assets at the end of the period exceeds the financial (or money) amount of net assets at the beginning of the period, after excluding any distributions to, and contributions from, owners during the period.

Physical capital maintenance. Profit is earned only if the physical productive capacity (or operating capability) of the entity (or the resources or funds needed to achieve that capacity) at the end of the period exceeds the physical productive capacity at the beginning of the period, after excluding any distributions to, and contributions from, owners during the period.

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At this stage, we verify if the concept of profit of the CF respects the formulations of truth (T3) and coher-

ence (C2), as they stand in section 2. Hence, the concept of profit in IASB CF is regarded as the sentence x.

Moreover, the system L is represented by the whole IASB system in terms of CF plus all the individual

standards.

T3 The IASB concept of profit is true in the IASB system if and only if either the concept of profit is a

member of the IASB system and the IASB system is coherent, or the concept of profit is a member of IASB

CF* where the IASB system made coherent according to the Quinean doctrine of minimal mutilation yields

the IASB system *.

Given that the concept of profit is included in IASB CF, the first of the two conditions of T3 is respected.

However, there is the need to prove the coherence of the IASB system through the reference to the formula -

tion C2.

C2 The IASB system is coherent if and only if, for all normative sentences related to the concept of

profit, if the concept of profit is a member of the IASB system, the concept of profit is consistent with all

other members of the IASB system and their normative implications and is derivable by a system of deductive

logic or inductive generalization with all other sentences of the IASB system and any requisite non-normat-

ive principles available as premises.

For the purpose of assessing the coherence of IASB system we analyse the elements of measuring profit

cited in Table 1, by referring to some explicative cases, in terms of incoherencies inside the conceptual

framework and between the conceptual framework and IFRS.

Incoherencies inside the conceptual framework in relation to the measurement of profit

Concerning the issues related to the measurement of profit, the first anomaly to take into account with refer-

ence to the CF is that, as Barker (2010) argues, the CF provides the definitions of income and expenses but

profit is not explicitly defined. Moreover, the author recognises that the definitions of income and expenses

are based upon the notion of clean surplus, whereby IFRS allows dirty surplus items, namely capital main -

tenance adjustments and reclassification adjustments (recycling), with the result that IFRS does not allow in-

come less expenses to be defined to equal profit. As a result, while all changes in net assets (other than from

transactions with equity holders) are by definition either income or expenses, those associated with capital

maintenance or reclassification adjustments are excluded from the calculation of profit in the income state -

ment.

In this regard, Barker stresses that the IASB’s answer to the problem of profit not being equal to income less

expenses has not been to redefine income or expenses, but to ‘reinvent’ profit by introducing a term that does

not exist in the CF, i.e. ‘total comprehensive income’, which should be effectively clean surplus profit by an-

other name. However, according to Barker’s analysis total comprehensive income has, to date, only in -

creased confusion and complexity because of its lack of conceptual merit.

Incoherencies between the conceptual framework and IFRS in relation to the measurement of profit

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The CF allows both financial and physical capital maintenance: on the one hand, under the concept of

financial capital maintenance, where the capital is defined in terms of nominal monetary units, increases in

the prices of assets held over the period are profits; on the other hand, under the concept of physical capital

maintenance, where the capital is defined in terms of physical productive capacity, all price changes

affecting the assets and liabilities of the entity are viewed as changes in the measurement of the physical

productive capacity of the entity, and they are treated as capital maintenance adjustments.

In relation to the application of the capital maintenance an interesting question pertains to IAS 41, which

provides rules for biological assets. Specially, the IAS 41 requires that changes in the fair value of biological

assets have to be treated as part of the profit or loss of the period. This accounting treatment implies the

application of financial capital maintenance. However, Roberts et al. (1995) argue that for the biological

assets the increase in fair value associated with changing prices should be differenced from changes in fair

value that are due to physical changes. However the capital maintenance implications need more precise

thought. Consider the situation of a farmer using mother cows to regularly breed calves. The mother is a

fixed (non-current) asset, retained over a number of years to support the operating activity of the business,

which is the breeding of calves. Since the mother is a fixed asset, she must be replaced when she wears out,

and it follows that any recorded gains on her, whatever the valuation method used, are not surplus over and

above the maintenance of the long-run operating capacity of the business. Whether these gains are realised

by market transaction (of the mother), or not, is completely irrelevant to this statement.

The situation regarding the calves is entirely different. These are logically ‘work-in-progress’ but the opera -

tion of the farm is to ‘grow’ calves, not to buy and sell them. So it is entirely rational to propose that gains on

the calves are part of the operating performance of the farmer. Again, this statement is logically entirely un -

affected by whether the gains are realised through market transaction of the calves, or not (realisation may

affect distributability, but it does not affect the calculation of the operating performance). So, applying this

logic more specifically to the IASB scenario of fair value and OCI, we can say that fair value gains on e.g.

lambs/calves are definitely operating items, and physical/operating capital maintenance is fully achieved by

retaining the mother animals subject to wear and tear. It follows that unrealised gains on the young are oper -

ating, and economically (not necessarily legally or prudentially) distributable at once. But if the mothers are

fair valued too, the gain on them does need to be retained. Essentially, the proper application of capital main-

tenance is that the fair value gain on lambs/calves (or grapes on the vine) goes immediately into income, and

gains on the parents (or the vine itself) go into other comprehensive income and stay there.

The example is highly topical. World Accounting Report for February 2013 (Walton, 2013) reports as

follows, in relation to the December 2012 meeting of the Board.

“The IASB also started work on the proposed amendment to IAS 41 Agriculture. They had agreed, in

response to a paper from the Malaysian Accounting Standards Board, supported by the Asian and Oceanian

Standard-setters Group (AOSSG), to look at providing different accounting for bearer biological assets.

While IAS 41 generally requires biological assets to be at a form of fair value, the AOSSG has made the case

that some biological assets are more like property, plant and equipment in that they are used to grow a

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consumable crop and not consumed themselves”.

The report goes on to say that the IASB rejected any such suggestion as regards ‘assets that (a) had no altern-

ative use and (b) were not livestock’. This suggests that they do not understand the logic of capital mainten-

ance in the real world of business.

A further explicative case is related to the IAS 16, Property, Plant and Equipment, and IAS 38, Intangible

Assets, which allow re-measurement subsequent to initial recognition applying the revaluation model: If a re-

valuation results in an increase in value, it should be credited to other comprehensive income and accumu-

lated in equity under the heading ‘revaluation surplus’ unless it represents the reversal of a revaluation de-

crease of the same asset previously recognised as an expense, in which case it should be recognised as in-

come. When a revalued asset is disposed of, any revaluation surplus may be transferred directly to retained

earnings, or it may be left in equity under the heading revaluation surplus. The transfer to retained earnings

should not be made through the income statement. This accounting treatment implies no recycling through

profit or loss. This revaluation model seems to be based on a physical capital maintenance concept to the ex-

tent that the increase of value is recognised in other comprehensive income and it seems to be based on fin -

ancial capital maintenance to the extent that the decrease of value is recognised in net income.

An additional explicative case is related to IAS 39, Financial Instruments: Recognition and Measurement.

The changes in fair value of financial instruments classified as available for sale are recognised directly in

other comprehensive income. This implies a physical capital maintenance concept. However, differently

from the revaluation surplus model of IAS 16 and IAS 38, the cumulative gain or loss recognised in other

comprehensive income is then recognised in profit or loss when an available-for-sale financial asset is

derecognised. This approach implies recycling.

Concluding, the first incoherence that it is possible to identify in relation to the IASB accounting system is

that the CF itself lacks coherence because the extant definitions of income and expenses, which are based on

a clean surplus approach, do not lead to income less expenses equal to profit. This is mainly because IFRS

allows dirty surplus accounting (i.e. capital maintenance adjustments and recycling), and are thus incoherent

with the CF. More in depth, taking into account the above cited examples, it is important to highlight that, al -

though the CF explicitly requires that an entity choose its concept of capital maintenance from between the

two allowed within CF, the IASB itself allows the co-existence of the two approaches in some individual

IFRS. Moreover, the application of capital maintenance is not always consistent with the expectation of some

items as for example with agriculture products. Further, in relation to recycling, being aware that the recyc -

ling option is not coherent with CF formulation, in any case the IFRS show an inhomogeneous approach to

such issues. Hence, it is possible to conclude that currently the IASB provides an incoherent and sometimes

misleading accounting system.

4. ECONOMIA AZIENDALE

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The Economia Aziendale is an Italian normative entity theory which dates back to 1927, through the work of

Gino Zappa, which studies the conditions of existence and the manifestation of the life of the entity (azienda)

(Zappa, 1927, p.30). In particular, the azienda (a concept that encompasses all types of entities, such as

profit-oriented, public, and non-profit) is defined as an economic institution intended to last for an indefinite

length of time and which, with the aim of meeting human needs, manages the production, procurement or

consumption of resources in continuous coordination (Zappa, 1956, p. 37; Signori and Rusconi, 2009).

The Economia Aziendale states that the azienda should be jointly analysed from three perspectives:

management, organization and accounting. This three-fold view implies the need to take into account the

interdependences between managerial, organizational and accounting aspects, from the point of view of

systematic relationships, to get a more comprehensive framework (Signori and Rusconi, 2009; Zappa, 1927,

p.25). Thus, one of the most distinguishing features of the theory is the unitary view of the azienda, which

leads to a holistic approach (Signori and Rusconi, 2009; Caldarelli et al., 2011; Costa and Ramus, 2012).

Accordingly, the first distinctive point is that the Economia Aziendale is based on the notion of the

azienda as a unitary and durable economic institution, with long-term objectives, that should be jointly ana-

lysed from three perspectives: management, organization and accounting.

As the Italian Society of Accounting Professors (Società Italiana dei Docenti di Ragioneria e di Economia

Aziendale, SIDREA) has recently argued, the main purpose of the azienda is to create value, for the azienda

itself – and not for the single persons within the institution – as well as for the different stakeholders

involved and socially recognised (SIDREA, 2009). Therefore, the Economia Aziendale focuses on the

conditions that the azienda should meet in order to ensure in the long term, either the persistence of the

institution or the accomplishment of the purposes for which it was founded (Sidrea, 2009). In particular, the

azienda should be able to preserve or even improve its level of functionality over time, through the

continuous realization of a positive difference between the benefits obtained and the resources employed (i.e.

economic equilibrium; equilibrio economico) (e.g. Catturi, 2003; Sciarelli, 2007; Cavalieri, 2010), also

paying attention to the asset-liability and cash flow dimensions (i.e. financial equilibriums; equilibrio

finanziario, equilibrio monetario respectively). Moreover, in so doing, it also compounds the attainment of

the strategic equilibrium (i.e. strategic equilibrium; equilibrio strategico) (Cavalieri, 2010).

Accordingly, the second distinctive point is that the azienda is able to survive in the long run if it is

able to create value for itself and the socially recognised stakeholders, by systematically achieving eco-

nomic, financial and strategic equilibriums.

Given the above discussion and in order to focus the attention on the accounting perspective, there is the

need to emphasise several aspects. It is worth highlighting that as Capalbo and Clarke (2006) stress, a

relevant underlying assumption of the Economia Aziendale is that no reliable accounting systems to assess

the value creation can be designed without having knowledge of the particular azienda’s operations,

managerial aspects and organizational structure. This is the natural consequence of the theoretical

formulation of the Economia Aziendale that tends to locate the azienda in its time-space setting. Indeed, this

conception is mainly based on the structure of the Italian economic context at the time of the original

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formulation of the theory, characterised by the prevalence of business-oriented, rather than financial-oriented

entities. Thus, originally Italian accounting was free from the constraints related to the need for providing

comparable information for financial markets, and more oriented towards the achievement of a

comprehensive understanding of the value creation processes useful for real entities. In this regard, it is

worth noting that to examine the concrete features of real entities the interdependences and the systemic

view assume a central relevance also for the definition of accounting systems. That is, as Zambon and Zan

(2000) state, within Italian literature it is difficult to identify any accounting conception, position or relevant

statement that does not mirror the basic elements of characterising the theoretical representation of the entity.

Further, although significant changes have occurred in the Italian economic context, agreement still persists,

among Italian accounting scholars, on the notion of azienda as a unitary and highly coordinated system.

Accordingly, the third distinctive point is that the unitary view and the high coordination which have

characterised the notion of the azienda since the very beginning, due to the prevalence of business-oriented

entities (real entities) in the (real) economic context of reference, is still largely agreed despite the signific -

ant changes which have occurred since 1927.

Moreover, since the azienda is perceived as highly coordinated and unitary, conceptually also the income is

unitary and envisaged as a holistic notion. Indeed, in acknowledging that all operations performed within the

entities are related to one another, Economia Aziendale emphasises the need for taking into account such

interdependences, with the subsequent impossibility to distinguish the financial consequences of one activity

from those of another. Hence, with specific reference to accounting, in theory any attempt to measure

periodically the performance of the azienda is improper because it interrupts the coordination. In this regard,

we quote Viganò (1996, pp. 266-7, our translation).

«The concern is unitary; the income1 produced is unitary, in time and space. (…) There are no single or

specific costs to be compared to single or specific revenues. A single cost does not produce a single revenue,

but it contributes without distinction to produce all the revenues; a single revenue does not derive from a

single cost, but from the contribution of all the costs. The concern is a dynamic entity, so what really exists

are costs and revenues as elements of the income itself».

In this respect, it is worth emphasizing that Italian accounting theory in this sense attempts to reflect the

holistic character of the azienda, without rejecting the practical exigencies of measuring performance

periodically, as to this aim the interruption of the coordination for preparing annual reports is tolerated (being

aware of the inevitable conjectures) as a stratagem. That is, coordination still persists despite this

compromise (Capalbo and Clarke, 2006) which is essential to achieve the practical needs related to the

periodical information required for external users, but should be carried out bearing in mind the characters of

unity and coordination over time and space.

Accordingly, the fourth distinctive point is that the Economia Aziendale adopts in essence a clean

surplus accounting that allows the respect of the essential holistic character of the azienda.

1 Income is here (and henceforth) a literal translation of the Italian term Reddito, which in IASB’s terms is to be understood as profit or loss.

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Another essential element to take into account is that, given the original conception of financial statements as

an internal instrument to provide an efficiency judgement on management, the relevant measure that the

accounting systems should provide is a measure of consumable (i.e. distributable) income and not one of

achieved (i.e. non distributable) income. Indeed, since the azienda is conceived as a durable institution, the

managers have to reject decisions that might favour short-term profit to the detriment of the long term with a

view to guaranteeing the economic long-term sustainability of the azienda (Amaduzzi 1991). In this regard,

it is worth noting that the notion of consumable income incorporates the concept of economic capital

maintenance as the preservation of the same capacity to produce income in the future, compared to that at the

beginning of the period. In this sense, Zappa (1937) and the following Italian scholars (e.g. Onida, 1951;

Amaduzzi, 1953; Masini, 1955; Amodeo, 1960) have variously highlighted the possible relevance of

different estimation criteria, but always having in mind that to avoid the lessening of capital in operating

terms, income available for distribution must not reduce the initial capital (in quantitative terms), and it must

not damage the capacity of capital to provide future income (from the qualitative perspective). Alexander

and Servalli (2011) discuss this logic in more detail, and see section 6 below.

Accordingly, the fifth distinctive point of the Economia Aziendale is that in order to determine a

reasonable measure of consumable income, it is essential to determine the qualitative-quantitative measure

of capital that preserves future income.

What should be noted is that Italy is characterised by the prevalence of small-medium or family enterprises,

phenomena of thin capitalization, with an under-developed financial market and high usage of financial

resources provided by financial intermediaries. Hence, the notion of economic capital maintenance arguably

serves two different scopes. Indeed, first, the preservation of the capital from the qualitative point of view

ensures the durability from the operating perspective. On the other hand the preservation of the capital from

the quantitative perspective ensures, also in accordance with the legal requirements that are typical of an

insider system such as Italy, the respect of capital providers’ rights.

Accordingly, the sixth distinctive point of the Economia Aziendale is that the notion of economic

capital maintenance fully reflects the real information needs of the azienda as a real entity.

5. IASB ACCOUNTING SYSTEM AND ECONOMIA AZIENDALE: TOWARDS A MORE

MEANINGFUL INCOME PRESENTATION

This section attempts to discuss the incoherencies of the IASB accounting system in contrast with the

coherence of the Economia Aziendale. Hence, we start by summarizing the most important issues addressed

in the third and fourth sections.

In particular, as far as the incoherence of the IASB accounting model is regarded, several aspects ought to be

deepened. As already pointed out in the third section, a number of elements such as the co-existence of clean

surplus accounting (which is at the basis of the CF) and dirty surplus accounting (which is allowed by some

individual IFRS in relation to capital maintenance adjustments and recycling); the co-existence, in certain

cases, of different capital maintenance approaches within the same IFRS; and more in general the

12

inhomogeneous application of the options across the IFRS, lead to an incoherent and misleading accounting

system. Arguably, as Alexander and Archer (2003) contended, this implies that the information provided on

the bases of such a system - which lacks clear conceptual foundations, and thus allows alternative or

conflicting practical approaches - possibly lacks decision usefulness for different kinds of user.

Contrarily, as it has been depicted in the fourth section, the Italian accounting is fully coherent in itself, i.e.

all the accounting concepts are rooted in the theoretical formulation of the Economia Aziendale. In summary,

it is worth emphasizing that the Economia Aziendale clearly states what are the essential characteristics of

the azienda (entity), as a unitary and durable economic institution, with long-term objectives. As far as the

durability is regarded, we stressed that the azienda is able to endure only if it creates value for itself and its

stakeholders. Moreover, since the azienda is perceived as unitary, its value creation processes can be

analysed only regarding simultaneously all the three perspectives of management, organization and

accounting that allow the full comprehension of the coordinated and systematic interdependences between all

the operations. Hence, as stated before, Economia Aziendale adopts in essence a clean surplus accounting,

thus incorporating the fundamental systemic view of the azienda. Moreover, given the long-term objectives

of the azienda, the theory focuses on the need for determining a reasonable measure of consumable income.

Indeed, the azienda is able to endure only if it creates value for itself and for the stakeholders, and it is able

to create value only if it determines the qualitative-quantitative measure of capital that preserves future

income. In this regard, clearly the notion of economic capital maintenance which emerges, fully reflects the

real information needs of the azienda as a real entity and of the different users.

On the basis of the elements of coherence of the Economia Aziendale, we discuss in the following

paragraphs the potential contribution of the theory in achieving a coherent IASB accounting system, able to

provide useful information for the different users.

In this respect, a primary focus should be on the call for reshaping accounting standards, after the financial

crisis, towards a new paradigm of sustainability. Indeed, Trichet (Chairman of the European Central Bank at

that time) emphasised during a seminar at the University Ca’Foscari of Venice in 2009, that during the crisis

the list of areas that proved dysfunctional included the risk management and credit assessment of banks,

accounting standards, audit quality, supervision, and many more elements, thus concluding that no market

segment or financial actor should escape profound rethinking. With specific reference to accounting

standards, the demand for switching from the pre-crisis short-termism towards visions of longer-term, in

conjunction with the widespread diffusion of IFRS around the world, possibly leads to a decisive

transformation of the bases for financial statements preparation. Indeed, the CF clarifies three fundamental

accounting assumptions, i.e. accrual, going concern and decision-usefulness which, given the above-cited

incoherence of the IASB accounting system, seems not completely satisfactory in view of these on-going

changes in the economic context.

In this regard, the Economia Aziendale may be helpful in elucidating a possible way forward to enhance

current provisions. Accordingly, if the IASB would enlarge its accounting assumptions, by including

durability, unitary view of the entity and systemic coordination, it could probably be able to provide

13

conceptual bases more relevant to the new economic challenges. The reliance on such concepts, as the

Economia Aziendale shows, on the one hand might be a good starting point to render accounting able to urge

entities towards long-term sustainability. On the other hand, these elements fit very well with the

characteristics of those countries that are adopting IFRS and that have a manufacturing, retail and service

tradition, with a vast majority of entities that are business-oriented rather than financial market-oriented.

Here such an approach would result in the improved capability of financial statements to deliver useful

information about the real productive nature of entities, rather than focussing only on financial orientation,

but clearly without compromising the information needs of financial-market oriented entities.

As stated above a second controversial issue refers to the fact that the CF adopts a clean surplus accounting

while some individual IFRS allow dirty surplus. In this respect, it is worth remembering that as Van

Cauwenberge and De Beelde (2007) maintained, the introduction of a statement of comprehensive income

mimics clean surplus income and this arguably demonstrates the preference of the IASB for retaining clean

surplus accounting. However, comprehensive income due to its lack of firm theoretical underpinnings

removes only the incoherencies related to capital maintenance adjustments, but the problem of recycling still

remains unanswered. On the contrary, bearing in mind that the Economia Aziendale is a tangible expression

of the strong linkage between the characteristic features of durability, unity and systemic coordination of the

entities, and clean surplus accounting, the introduction of these concepts as assumptions in the IASB

accounting systems might be beneficial also with regard to the misleading co-existence of clean surplus

accounting and dirty surplus accounting relating to recycling. Indeed, the removal of recycling might be able

to render the IASB accounting system less complex, more coherent and thus able to provide more useful

information for different users.

In addition, we have also contended that the IASB accounting system is characterised by incoherence with

reference to the concepts of capital maintenance. Whilst the CF holds both financial and physical capital

maintenance, requiring that entities choose their concept of reference between the two allowed, the IASB

itself allows the co-existence of the two approaches in particular IFRS. In this regard we agree with the IASB

view of the importance of holding the two different approaches to fully meet entities’ information needs.

However, in light of the misleading application of these across the standards, we suggest a different approach

to achieve coherence. In this perspective, the Economia Aziendale notion of economic capital maintenance

represents a good and potentially valuable example of simultaneous and coherent application of the concepts

of financial and physical capital maintenance. The adoption of such an approach ensures the retention of both

concepts, which is an expressed willingness of IASB, and at the same time the achievement of coherence.

Still, it is worth emphasizing that in view of the widespread diffusion of IFRS around the world, in countries

where there is the prevalence of business-oriented entities, a coherent accounting system, which is able to

provide information on the preservation of the capital from the qualitative and the quantitative point of view,

fully satisfies the needs of different users including, but certainly not limited to, capital providers.

6. THE BUSINESS MODEL, FAITHFUL REPRESENTATION, COHERENCE AND ECONOMIA

14

AZIENDALE

We now apply our thinking to current developments relating to the IASB revised Conceptual Framework

(CF) project. EFRAG have recently issued a series of five ‘bulletins’ under the general heading of ‘Getting a

Better Framework’. We refer to two of these here (EFRAG 2013a; 2013b). EFRAG points out that the

already revised sections of the CF (for which further amendments are explicitly not to be considered in the

immediate future) emphasise ‘faithful representation’. They state  (EFRAG 2013a: para 16) as follows.

“Information is said to have faithful representation when it ‘faithfully’ represents the phenomena that it pur-

ports to represent”. The CF states that a perfectly faithful representation would be complete, neutral and free

from error, although perfection is seldom, if ever, achievable. The Basis for Conclusions states that faithful

representation ‘encompasses the main characteristics that the previous frameworks included as aspects of re-

liability’, although it also mentions that ‘substance over form, prudence (conservatism) and verifiability,

which were aspects of reliability in the previous framework are not considered aspects of faithful representa-

tion’.

This, in the classic English phrase, is as clear as mud. A 2-word phrase is defined in 9 words, which them -

selves include the first keyword once and the second keyword twice. This is not good philosophy! We find

no rationale for distinguishing, as the IASB do, ‘faithful representation’, as above, from ‘fair presentation’,

as in IAS 1, although in hierarchical terms they are clearly seen as having different roles, with fair presenta-

tion being superior. We suggest that either faithful representation means nothing, except that the reporting

‘does what it says on the tin’, whatever the tin actually says, or it should be interpreted pragmatically as ‘not

misleading’. Not misleading to whom, and for what decision-making purpose, remains to be determined, of

course.

This leads on to consideration of the ‘business model’, the subject of EFRAG 2013b. Para 12 states:

“Our assumed meaning of the term ‘business model’ focuses on the value creation process of an entity, i.e.

how the entity generates cash flows. In case of non-financial institutions, it represents the end-to-end value

creation process or processes of an entity within the business and geographical markets it operates”. A busi -

ness model is obviously entity specific. This logically rules out the use of fair value as defined in IFRS13,

which is ‘a market-based measurement, not an entity-specific measurement’ (para IN9). The emphasis on

cash flows, confirmed in para 25 of the same EFRAG document, is important. EFRAG 2013b builds much of

its argument on a hypothetical example, given in para 7, which we quote complete.

“Suppose an entity purchases a quantity of cotton for CU100. It still owns the cotton at the reporting date,

when it is worth CU120 (and the entity could readily sell it at that price). If the entity is a shirt manufacturer

and will use the cotton in its operations, current practice would be simply to report the cotton as ‘inventory’

at its cost of CU100. But if the entity is a commodity trader that seeks to make profit from short-term price

movements, that accounting may not reflect fairly the entity’s financial position or financial performance:

current practice reflects this view by stating the asset at its current selling price of CU120, with the gain of

CU20 included in profit. However there might be other ways in which the business model might impact the

financial statement: if the transaction is a non-recurring speculation that is outside the normal activities of the

15

entity, it would probably have to be separately presented, whatever the accounting treatment. Thus the nature

of an entity’s business may affect the measurement of assets, the reporting of profit and presentation”.

At first glance, this perhaps sounds unproblematic. There are certainly issues of presentation, and the precise

business model may indeed impact the necessary reporting mechanisms. But in the broader scheme of things,

this is inadequate, and indeed incoherent in precisely the sense of our paper. By implication, the ‘market

price’ (buying or selling) of the cotton has risen to CU120. What we are looking for is a means of financial

reporting which gives a ‘not misleading’ picture of the effects of the situation, for this entity, on cash flows.

If the business is a cotton trader/speculator, then the ‘gain’ of CU 20 is an unrepeatable ‘oneoff’, and must be

reported as such. To sell a second batch of cotton, the trader must replace the first batch, presumably at

CU120. So the cash flow picture will be -100 (the opening ‘capital’) +120 - 120, the last two items repeated

to infinity, and the ‘gain’ of 20 only physically appearing when ‘infinity’ actually arrives. Those interested

should explore Edwards and Bell (1961) and the distinction between a holding gain and a cost saving.

But in the general case, the entity is a shirt manufacturer. So the cotton is used in production to make shirts,

which are then sold. And what happens next within this business model? More cotton is purchased, to make

more shirts. So in terms of cash flow effects, what is the information content of the knowledge that the price

has risen from 100 to 120? In terms of positive cash flows, the information content is very little. The entity

may well wish to increase the selling price of shirts to recover the extra 20. It may, or may not, be able to do

so, since this is a market and marketing issue, not a cost issue. In addition, note that as a profit maximiser,

the entity would increase the price if it was economically beneficial to do so, even if the cost had never in -

creased at all! 

However in terms of negative cash flows the knowledge is extremely informative. It tells us that according to

all the available information, past negative cash flows of a series of payments of CU100 will be replaced by

future negative cash flows of a series of payments of CU 120. So the informational message from the ‘in -

crease’ from 100 to 120 is that the present value of future expected net cash flows, ceteris paribus, has re -

duced. The real reporting issue is not how to show and make transparent the ‘gain’ (the word used in para 7

as quoted), which the EFRAG document considers. It is how to show and make transparent the loss in future

profitability. Only by properly achieving this can we claim to ‘focus on the value creation process of the en-

tity’ as required in para 12 quoted above. Anything less fails to give a faithful representation of ‘the phenom-

ena which it purports to represent’. Anything less fails to accord with the business model of the (specific) en -

tity (‘how the entity generates cash flows’). Anything less fails to be coherent, in the sense of our C2 in sec -

tion 3 above, with the objectives of, and the necessary usefulness and relevance of, the IFRS reporting pro -

cess as a totality.

The attentive reader, and particularly the attentive Italian reader, may have realised that we have actually un -

dersold our arguments here. What we are really talking about is the importance of considering long-run oper -

ating capital maintenance. This, as we have already mentioned at the end of section 5, is a fundamental ele -

ment of Economia Aziendale. So our invitation to read Edwards and Bell is really unnecessary, unless you

are a narrow-minded Anglo-Saxon. Zappa (and indeed by a different route Besta, not to mention Schmidt,

16

Limberg ...) got there first. Alexander and Servalli (2011: 8), writing in English, quote Zappa to support this

statement: “Income available for consumption, or which is available for levy or distribution, must not only

not reduce the initial capital, but it shouldn’t even damage the capacity of capital to provide an income: in-

come is essentially a surplus value, whose making leaves unimpaired the value which is the mechanism for

its creation” (Zappa 1946: 267)2. They further (2011: 9) quote Zan to show that Besta had the same theoreti-

cal conclusion: “Zan (1994: 288) also confirms that Zappa's conclusion is by no means new.  Referring to

Besta, Zappa’s great predecessor (and his one-time teacher), he states that Besta ‘argues that elementary

accounts should state the true and real value of individual assets, representing their replacement costs...’.”

Our proposition that Economia Aziendale provides relevant and coherent arguments which would be useful

to the conceptual framework development is directly supported. The same arguments would have increased

the relevance, usefulness and coherence of the newly issued Directive repealing and replacing the Fourth and

Seventh Directives (Directive 2013/34/EU, issued 26 June 2013). This, by silent omission (see Preamble

paragraph 18, and Articles 6,7 and 8), does not permit the use of replacement cost for inventory, and appears,

not necessarily successfully, to intend not to permit its use for fixed assets (sic) either (the obscurities of Ar-

ticle 7, which we have read in five languages, giving different nuances, are beyond our scope in this paper).

In summary from the detailed illustrative discussion in this section, Economia Aziendale does indeed have

much to offer current developments, in terms of logical coherence.

7. CONCLUSIONS

This paper attempted to examine the issues relating to the incoherencies in reporting holding gains and losses

in the current IASB accounting system, by focusing on the possible contribution of the Economia Aziendale

theory in removing those elements that produce incoherence. The reference to a traditional accounting

theoretical approach, as it has been suggested by Newberry (2003), and in particular to the traditional Italian

theory, has a twofold reason. Indeed, the Economia Aziendale represents a coherent framework capable to

provide coherent information in financial statements, that is useful for different kinds of users and

information needs. Moreover, an essential element that justifies the reference to the Economia Aziendale is

that such a theory pushes fuller information on the real productive nature of entities, rather than focussing

only on financial orientation, which fits the information needs of the countries that are increasingly adopting

IFRS and are characterised by a business-oriented tradition.

The discussion highlighted that the failure so far of the IASB to complete its reporting comprehensive in -

come project in a manner fully articulated and leading to a consistent and rationalised approach across the

whole set of Standards, is unfortunate and reprehensible. Indeed, despite the CF focus on clean surplus ac-

counting, IFRS still allow dirty surplus accounting relating to reclassification adjustments, which have the

2 Il reddito devoluto al consumo, o che si può prelevare o distribuire, non solo dunque deve essere tale da non diminuire il capitale iniziale, ma nemmeno dovrebbe intaccare l’attitudine del capitale a fornire un reddito: il reddito è essenzialmente un valore eccedente, che nel determinarsi lascia integro il valore che è mezzo di sua rilevazione ” (Zappa 1946: 267).

17

effect of deferring the recognition of profit or loss in the income statement to a date subsequent to that of the

initial OCI recognition. As a result, the incoherence still persists, in that profit includes items that are neither

income nor expenses under the CF, because of the recycling into the income statement. Moreover, individual

IFRS sometimes display a lack of theoretical foundation in the concepts of capital maintenance taken as a

reference, so that they are applied in a muddled and ambiguous manner, thus uncovering an additional ele-

ment of incoherence.

However, it is worth remarking that the Economia Aziendale and the IASB conceptual framework share a

common focus on clean surplus accounting, on the maintenance of the long-run operating capability of an

entity, ensuring its capacity to replace all consumed resources (capital maintenance) and to continue in oper -

ation (going concern). Therefore, we argued that the Economia Aziendale tradition has a real contribution to

offer towards the achievement of a coherent IASB accounting system. In summary, we contend that if the

IASB would enlarge its accounting assumptions, by including durability, unitary view of the entity and sys-

temic coordination, it could be able to provide more valuable conceptual bases in relation to the increasing

call for sustainability and the delivering of useful information about the real productive nature of entities.

Also we maintain that these would be advantageous to fully realise clean surplus accounting, also outside the

CF, thus rendering the IASB accounting system coherent, less complex and more useful. Finally, we advoc-

ate the introduction of a comprehensive concept of capital maintenance, i.e. the economic capital mainten-

ance pursued by the Economia Aziendale, because it allows the provision of information on the preservation

of the capital from both the qualitative and the quantitative point of view, which fully satisfies the needs of

different users as well as capital providers.

Concluding, what should be noted is that the Economia Aziendale, although it is not very well known abroad,

has something to say also into the international accounting arena. Indeed, this theory could provide a

valuable starting point to reasoning on how to improve the current IASB accounting system, both at the level

of the CF and of the IASB standards.

This in our view is relevant not only for academicians and practitioners, but more in general for policy

makers and local standard setters. Moreover, the integration of concepts such as those that the Italian theory

pursues, could potentially encourage the adoption of IFRS in those (doubtful) countries presenting similar

characteristics to Italy. In this regard, our opinion is that we, the IASB and its advisers, have much thinking

still to do.

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