response to the iasb’s dp/2013/1 a review of the...
TRANSCRIPT
1
Response to the IASB’s DP/2013/1 A Review of the Conceptual
Framework for Financial Reporting
10 January 2014, Carien van Mourik, [email protected]
Open University Business School, Walton Hall, Milton Keynes, UK, MK7 6AA
General comments
The July 2013 IASB Conceptual Framework Discussion Paper (DP) revisits Chapter 4
of the 2010 IASB Framework, which is the remaining text from the 1989 IASC
Framework and concerns the definition, recognition and measurement of the elements
of financial statements. Chapters 1 and 3 of the 2010 IASB Framework and the
Exposure Draft for Chapter 2 are the result of a joint project by the IASB and the
FASB. This project was never meant to critically assess the logic and appropriateness
of the objective of general purpose financial statements and the qualitative
characteristics of useful information for application to financial reporting in an
international context. It was a convergence project meant to iron out differences
between the IASB and FASB frameworks.
This time, the IASB decided to complete its Conceptual Framework on its own rather
than as part of a convergence project with the FASB. The reasons for doing so are not
crystal clear, although it seems to me that it is the right thing to do. After all, the
FASB must serve the public interest in the US and the IASB must serve the
international public interest, and the public interest is not necessarily the same in both
contexts.
In Question 22, this DP states:
‘The IASB will make changes to those chapters if work on the rest of the
Conceptual Framework highlights areas that need clarifying or amending.
However, the IASB does not intend to fundamentally reconsider the content of
those chapters. Do you agree with this approach? Please explain your reasons.
If you believe that the IASB should consider changes to those chapters
(including how those chapters treat the concepts of stewardship, reliability and
prudence), please explain those changes and the reasons for them, and please
explain as precisely as possible how they would affect the rest of the
Conceptual Framework.’
2
I do indeed believe that the IASB will need to comprehensively and fundamentally
reconsider the objective of general purpose financial reporting, the definition of
reporting entities, the qualitative characteristics of information that satisfies the
objective, the ways in which financial reporting information satisfies the objective,
and what this means for the definition, recognition, measurement, presentation and
disclosure of the elements of financial statements. This will help the development of a
theoretically and logically coherent Conceptual Framework. Chapters 1, 2 and 3
imply normative judgments and assumptions on which the actual accounting
framework rests, and which therefore ought to be openly stated and much more
seriously scrutinised and carefully justified than they currently are.
A comprehensive review cannot easily be done following the building block approach
used in the joint IASB/FASB project or in the 2013 DP because the assumptions and
logic behind them must be clarified, evaluated and justified in accordance with the
IASB’s mission and mandate (not those of the FASB in 1978 or the IASC in 1989).
The DP shows that the building block approach is very much engrained in the IASB’s
way of thinking about the Conceptual Framework. Unfortunately, thus far this
approach has prevented the articulation and justification of the IASB Framework’s
underlying assumptions and the logic (hinted at in OB1) according to which the other
elements of the Framework flow from the objective of general purpose financial
reporting. This logic would explain how, according to the IASB, the objective of
general purpose financial reporting translates into the definition, recognition,
measurement, presentation and disclosure of the elements of financial statements of a
specific reporting entity.
This comment letter will first answer question 1 and then move to question 22 before
addressing the other questions in the DP in the regular order.
3
Question 1
Paragraphs 1.25-1.33 set out the purpose and status of the Conceptual Framework.
The IASB’s preliminary views are that:
a) The primary purpose of the revised Conceptual Framework is to assist the
IASB by identifying concepts that it will use consistently when developing and
revising IFRSs, and
b) In rare cases, in order to meet the overall objective of financial reporting, the
IASB may decide to issue a new or revised Standard that conflicts with an
aspect of the Conceptual Framework. If this happens, the IASB would describe
the departure from the Conceptual Framework, and the reason for that
departure, in the Basis for Conclusions of that Standard.
Do you agree with these preliminary views? Why or why not?
a) No. Whether the IASB likes it or not, the current role of the IASB Conceptual
Framework has grown much wider than it was originally designed for when
the IASC Framework Steering Group worked on it from 1987 to 1989. At that
time, the idea was that when reducing the number of options in the IASs this
needed to be done in such a way that it could be shown that there was an
overall logic and coherence to the standards. Since then, the IASB has become
an actual international standard setter that needs to be able to stand its ground
when under political pressure from different interest parties. It is now the
IASB’s responsibility to make sure that its Conceptual Framework sets out a
theoretically sound and coherently integrated set of principles and concepts
underlying IFRS. The social responsibilities of the IASB have grown with the
diversity of institutional environments where IFRS are used and the diversity
of reporting entities that use IFRS. The Framework has become part of the
effort to establish a more comprehensive theory of accounting. It has gained
prominence in the education of many accounting students world-wide. This is
a heavy responsibility and perhaps too much to ask of the IASB on its own,
but the Framework is not like the Standards. The Framework is first and
foremost based on normative choices which involve value judgements
affecting the general public. With responsibility for such choices comes social
as well as intellectual and political accountability.
b) No. Building the comply-or-explain approach in from the start opens the door
to departures from sound principles for political reasons. The danger here is
4
that the Framework will be used as a legitimising tool to do what is in the
IASB’s own prudential interest. One of the main purposes of an accounting
conceptual framework is to use it as a weapon against political and self-
interested interference in standard setting. This requires the Framework to be
theoretically sound, epistemically justifiable, be supported by the IASB’s
constituents, as well as applicable in practice. It also requires the IASB to be
clear about its own and other perspectives on its social responsibilities as the
world’s international accounting standard setter.
Question 22
Chapters 1 and 3 of the existing Conceptual Framework Paragraphs 9.2–9.22
address the chapters of the existing Conceptual Framework that were published in
2010 and how those chapters treat the concepts of stewardship, reliability and
prudence. The IASB will make changes to those chapters if work on the rest of the
Conceptual Framework highlights areas that need clarifying or amending. However,
the IASB does not intend to fundamentally reconsider the content of those chapters.
Do you agree with this approach? Please explain your reasons.
If you believe that the IASB should consider changes to those chapters (including how
those chapters treat the concepts of stewardship, reliability and prudence), please
explain those changes and the reasons for them, and please explain as precisely as
possible how they would affect the rest of the Conceptual Framework.
The IASB should fundamentally reconsider Chapters 1 and 3 in combination with
Chapter 2 before amending Chapter 4 for the following reasons.
1. The current objective of general purpose financial reporting, the reporting
entity and the qualitative characteristics of information that satisfies the
objective are based on normative assumptions that were, perhaps, generally
accepted in the USA environment of the 1970s as set out in SFAC No. 1. The
decision-usefulness objective has not been justified and its underlying
assumptions have not been questioned in a due process commensurate with the
IASB’s technical, social and political responsibilities as a global accounting
standard setter functioning in a multitude of the different institutional
environment where IFRS has been adopted.
2. The underlying logic and normative assumptions with respect to global capital,
financial, product and other markets and the role of (multinational)
corporations in such markets are not explicitly stated. SFAC No. 1 explicitly
5
stated the assumptions on which the FASB Framework was based in the
‘Environmental Context of the Objective’ in SFAC 1 (FASB, 1978: Par. 9-16).
For example, the decision usefulness objective is justified based on the idea
that within a jurisdiction, the role of financial reporting is to promote the
allocation of resources to the entities making the most efficient use of them.
The IASC Framework made no mention of this assumption. Across different
jurisdictions and institutional environments with different institutional
complementarities it would be more difficult to justify, the IASC probably
thought it better not to state this assumption in its 1989 Framework. By 2001
and again in 2010, people had come to take the decision-usefulness objective
for granted and saw no reason to question the validity and fairness of the
assumption in an international context.
3. The building block approach has caused the IASB Framework to be
inconsistent because parts have been influenced by different people with
different ideas and agendas at various points in time.
4. The decision-usefulness objective has not been interpreted and further
developed in a manner consistent with Staubus’ Decision-usefulness Theory
or his Residual Equity Theory. The FASB and the IASB appear to have cherry
picked from the accounting literature without giving due reference to sources
or explaining the relative strengths and weaknesses of concepts and theories
they use or discard. Even more importantly, the IASB members seem to think
that they can mix and match concepts and logics as they please or as per the
outcome of some kind of social choice mechanism. A lack of respect for
theory or perhaps theoretical awareness is evident from the way the issue of
recycling or not recycling of OCI is discussed, or how there is no discussion of
articulated versus non-articulated financial statements and the role of clean
surplus in valuation and articulation or the reconciliation between cash flows
and accruals-based profit or loss.
The objective of IFRSs
Without explicit normative assumptions as to the social meaning of the allocation of
resources across reporting entities in global capital, product and other markets, or a
financial performance concept to provide the logic that binds the elements of the
conceptual framework together in a coherent manner, the DP leads into discussions
6
that are disjointed and confusing. If the IASB’s reason for being is to establish IFRSs
in the international public interest, the IASB will need to reconsider the Conceptual
Framework in its entirety and clarify its underlying methodological (philosophical)
assumptions, starting with a definition of the international public interest and an
explanation of the ways in which IFRSs serve it. Simply stating that it is in the public
interest to have a single set of high quality financial reporting standards is no longer
sufficient. For a discussion of the public interest in international financial reporting
standard setting, please see Van Mourik (2013b).
The objective of general purpose financial reporting
A perspective on the allocation of resources in global capital and other markets and
the justification of private property rights in multinational corporations listed at
multiple stock exchanges in different countries provides normative assumptions as to
the objectives of general purpose international financial reporting. The FASB based
its Framework on Staubus (1959, 1961)’s decision-usefulness objective which focuses
on predicting future cash flows because this suited the institutional environment on
the USA in the 1960s and 70s described in ASOBAT (AICPA,1966) and SFAC No. 1
(FASB, 1978: Par. 9-16). These paint a picture of a ‘highly developed exchange
economy’ (FASB, 1978: Par. 10) where investment is characterised by ‘a complex set
of intermediaries which offer savers diverse types of ownership and creditor claims,
many of which can be freely traded or otherwise converted into cash’ (FASB, 1978:
Par. 11). ‘Most productive activity in the United States is carried on through investor-
owned business enterprises, including many large corporations that buy, sell and
obtain financing in national or multinational markets’ (FASB, 1978: Par. 12). ‘(W)ell-
developed securities markets tend to allocate scarce resources to enterprises that use
them efficiently and away from inefficient enterprises’ (FASB, 1978: Par. 13).
The last point is extremely important in an international context because within a
single jurisdiction, there will be complementary institutions that ensure that the losers
are somehow compensated so that they do not become too disenfranchised. In an
international context, we need to keep in mind that institutional complementarities
vary across jurisdictions (See Leuz, 2010) and this may pile significant social costs on
those environments where more entities have problems competing globally.
7
Now IFRS has been adopted in many different jurisdictions, it is necessary to better
understand the different weights of the roles that financial reporting plays in different
institutional environments because the international allocation of scarce resources
potentially has more far-reaching social and economic consequences than the IASB is
willing to consider. In most environments, investor decisions based on predicted
future cash flows is probably not the only or even the main objective that needs to be
satisfied by general purpose financial statements. It is highly doubtful that information
useful for this objective is equally useful to satisfy the other main objectives of
general purpose financial reporting.
Proprietary Theory, Residual Equity Theory (better known as Decision-usefulness
Theory (Staubus, 1959 and 1961)), Entity Theory and Enterprise Theory (Suojanen,
1958?) represent four perspectives on the role of accounting for the private property
rights in what Fama & Jensen (1983) called ‘open corporations’. See Van Mourik
(2010) for a literature review of the equity theories in accounting and Van Mourik
(2013a: 56-60) for a discussion of objectives of external reporting under Proprietary,
Entity and Enterprise Theory. If my interpretation is correct, the objectives of
financial reporting under the four equity theories are:
1. to enable managers to discharge their stewardship responsibilities to the
entity’s shareholders by determining and reporting increase the owners’
wealth measured as financial capital (Agency or Proprietary perspective: a
corporation is a means for owners to increase their wealth)
2. to enable residual equity holders and other investors to make their economic
decisions with respect to the corporation by enabling them to predict future
cash flows to the entity and ultimately to themselves, by determining and
reporting the value of and the increase in the residual equity holders’ wealth
measured as financial capital (Decision-usefulness or Residual Equity
perspective: a corporation is a means for investors to increase their wealth)
3. to co-ordinate and reconcile conflicting interests in the corporation in order to
ensure the entity’s survival through the fair determination of profit for
distribution to shareholders whilst protecting all the stakeholders’ interests by
maintaining the current operating capacity of the entity’s productive capital
(Entity perspective: a corporation is a social entity that has to fulfil the needs
of all its financial stakeholders in order to survive), and
8
4. to co-ordinate and reconcile conflicting interests in the corporation in order to
ensure its survival through the ensure the entity’s survival through the fair
determination of profit for distribution to shareholders whilst protecting all the
stakeholders’ interests by maintaining the current operating capacity of the
entity’s productive capital, and to provide accountability to the wider public
for the value created and distributed, and for being a responsible corporate
citizen (Enterprise or Social perspective: a corporation is a social entity that
has to fulfil the needs of all its stakeholders in order to survive and hence it
must be accountable to all its stakeholders).
The objective of general purpose financial reporting in the IASB Conceptual
Framework is the same as that under Residual Equity Theory (or Decision-usefulness
Theory). This implies that the IASB regards multinational corporations as means for
residual equity holders and other international investors to increase their wealth, and
the role of financial reporting is to enable them to make investment decisions.
Personally, I believe that, as an international standard setter, the IASB would do well
to accommodate all four normative perspectives in its Conceptual Framework because
none of these can be chosen based on objective criteria or through social choice
mechanisms. Furthermore, the IASB must pay attention to the specific agency
problems and perverse incentives to engage in regulatory arbitrage (not only in terms
of compliance with accounting regulation but also other legal requirements and
enforcements such as those pertaining to taxation and company law, etc.) in the case
of multinational corporations.
How to satisfy the objective of general purpose financial reporting,
particularly in an international context?
Under a system of articulated financial statements, a financial performance concept
provides the logic as to how a specific financial accounting and reporting model
satisfies the chosen objective. By ‘financial performance concept’, I mean the set of
logic and principles underlying the definition, recognition, measurement, presentation
and disclosure of the elements of the statement of financial performance. The
financial performance concept is connected to the logic and principles underlying the
definition, recognition, measurement, presentation and disclosure of the elements of
9
the statement of financial position, the cash flow statement or the statement of
changes in equity through the articulation of financial statements.
Black (1993) and the G4 + 1 Position Paper by Cearns et al, (1999) advocate
decoupling the measurement and recognition principles underlying the statement of
financial position from those underlying the statement of financial performance. They
appear to think that this would improve the decision-usefulness of financial statement
information. This IASB DP, too, seems open to embracing the non-articulated system
of financial statements because it discusses bridging items in OCI without tying
recycling of the elements in OCI to the realisation concept. I do not know if this
produces useful information for investors, but non-articulated financial statements
could very well be the end of double-entry bookkeeping and accounting as we know it.
The implications for accounting’s role in stewardship, contracting, capital
maintenance and the protection of the interests of investors, creditors and other
stakeholders in the longer term are not yet known. Non-articulated financial
statements will also do away with the clean-surplus relation which is essential in
certain valuation models.
It is odd that the IASB has not included performance reporting and revenue and
expense recognition in the Conceptual Framework. An accounting conceptual
framework is incomplete without an explicit financial performance concept such as
realised net income (profit or loss), realisable income or released-from-risk net
income (in the Japanese Conceptual Framework). Net income realised on a
transactions basis is often regarded as a current operating concept of profit whereas
comprehensive income which is realisable on a valuation basis discloses both realised
and realisable income as an all-inclusive concept of profit. Without any clear
principles indicating the certainty and nature of the relationship between cash flows
and accruals, the qualitative characteristics in an accounting conceptual framework
have little operational value as a guiding principles for dealing with the allocation
problem in accounting (Thomas, 1969) and providing logical bases for accounting
standards for general purpose financial statements.
10
Question 2
The definitions of an asset and a liability are discussed in paragraphs 2.6 – 2.16. The
IASB proposes the following definitions.
a) An asset is a present economic resource controlled by the entity as a result of
past events.
b) A liability is a present obligation to transfer an economic resource as a result
of past events.
c) An economic resource is a right, or other source of value, that is capable of
producing economic benefits.
Do you agree with these definitions? Why or why not? If not then what do you suggest?
No. First, I do not agree that for general purpose financial reporting purposes an asset
should be defined as a resource. The idea that it needs to be capable of producing
future economic benefits is very similar to the old idea of assets as capitalised
expenses or service potentials which are meant to produce future income. To me these
definitions are all the same and they express an idea which is given within the
investment and production cycle of a business.
Second, I do not agree that the objective of general purpose financial reporting is
served by defining assets, liabilities, revenues/gains, expenses/losses separately from
the criteria to recognise them in the financial statements. The IASB should reconsider
the definition, recognition, measurement, presentation and disclosure of financial
statement elements from a perspective that links any definitions through an explicit
logic to the objective of financial reporting by corporate reporting entities.
Suggested definitions:
Asset: As a financial statement element an asset is a private economic good:
for which either the whole bundle of private property rights or the private
property rights related to its ownership, control and use, the generation of
income and the receipt of cash from the good are legally enforceable,
quantifiable in monetary terms in accordance with the characteristics of the
markets in which the good is (or the separable private property rights related
to the good are) bought and sold,
and which is/are held by the reporting entity.
11
Liability: As a financial statement element a liability is a legally enforceable claim on
the entity to transfer cash or other private economic goods (including the provision of
services) to fulfil an obligation which has arisen as a result of a past transaction,
action or event. It could include obligations that are entered into for prudential (i.e.
self-interested) purposes or moral (i.e. ethical or social) purposes.
Economic good: A product or service which can command a price when sold (Oxford
Online Dictionary). Other definitions are possible and may refer to the scarcity of the
good or service.
Private good: A private economic good is characterised by excludability and
rivalrous consumption.
Private property rights: Private property rights include the right to make use of a
good, to earn income from it, to lease it, to temporarily or permanently transfer
control of it to another party, to subdivide it, and to sell it. Legal definitions may be
more precise than this.
Net assets: Assets less liabilities.
Surplus: Net assets less share capital. The elements of surplus need to be clarified.
As the IASB Framework is to some extent based on Decision-usefulness Theory, it
adopts a mixed Proprietary/Residual Equity perspective on corporations that are a
going concern, and hence defines assets, liabilities and regards equity as the residual.
If it were based on Entity Theory of Enterprise Theory it would define surplus (net
assets – share capital) share capital, realised and unrealised revenues/gains and
expenses/losses separately, and it would pay attention to the separate definition,
recognition, measurement, presentation and disclosure of those elements in surplus
that are to be maintained and those that can be distributed. These may vary across
jurisdictions, but that is no reason not to discuss their definition, recognition,
measurement, presentation and disclosure in the Conceptual Framework.
Question 3
Whether uncertainty should play any role in the definition of an asset and a liability,
and in the recognition criteria for assets and liabilities, is discussed in paragraphs
2.17 – 2.36. The IASB’s preliminary views are that:
a) The definitions of assets and liabilities should not retain the notion that an
inflow or outflow is expected. An asset must be capable of producing
12
economic benefits. A liability must be capable of resulting in the transfer of
economic resources.
b) The Conceptual Framework should not set a probability threshold for the rare
cases in which it is uncertain whether an asset or liability exists. If there could
be significant uncertainty about whether a particular asset or liability exists,
the IASB would decide how to deal with that uncertainty when it develops or
revises a Standard on that type of asset or liability.
c) The recognition criteria should not retain the existing reference to probability.
Do you agree? Why or why not? If not, what do you suggest?
a) In business an asset is usually acquired because it is intended to generate income
and net cash inflows in the future. There is no need to refer to expectations or the
capacity to produce future income and net cash inflows, but there would be a need to
refer to intended use as this is what influences an asset’s subjective value.
This might lead into a discussion of business models where some assets are meant to
be used in a transformation or value adding process (manufacturing, wholesale, retail
and most services) and others are primarily held to benefit from increases or
fluctuations in market prices (investment property and certain financial investments
and financial instruments). Some of those assets are tangible, others are intangible,
some are traded in fairly complete and efficient markets and others are traded in
markets where prices can be influenced by the activity or volume of a single (or a few)
buyers or sellers. Referring to probability thresholds in order to indicate the
uncertainty of the expectations with which economic goods are held would be
oversimplifying the idea of an asset. The definition of an asset as a financial statement
element is not separate from its recognition, measurement, presentation or disclosure
and needs to be considered in relation to the primary financial performance concept
underlying the accounting/reporting system.
Section 3 of the DP strongly resembles the discussions on the deficiencies of the
matching concept. Section 3 presents the same (allocation) problem, looked at from a
different side. Assets defined as resources are not necessarily real things that can be
objectively defined, recognised and measured. It involves a similar subjectivity as the
old matching concept.
13
Defining liabilities would depend on one’s view of the function of the reporting entity
in society. Must liabilities be only legally enforceable obligations that determine the
net assets i.e., the residual interest of the common shareholders? Or should they
include the obligations to which an entity has committed due to the expectations from
a broader group of stakeholders? Or the obligations the entity would need to take
upon itself in order to present a favourable image in order to maintain the public’s
support and patronage? The explanation of ‘constructive obligations’ in Section 3
implies that constructive obligations would ideally be objectively determined, but for
a large part it depends on intention which is not objective.
b and c) The recognition criteria for assets and liabilities in the IASB Framework are
automatically the recognition criteria for changes in assets and liabilities. When the
recognition of assets and liabilities is tied to the recognition of realised or realisable
changes in assets and liabilities, the question of how to deal with existence uncertainty
and outcome uncertainty is not separate. There is no faithful representation (in the
sense of something corresponding to the economic reality it purports to represent) of a
given probability. There is only a calculated probability for which the assumptions,
the estimated and actual numbers and the methods and calculations can be at best
verified or at least judged to be reasonable.
If assets or liabilities are recognised based on such probability calculations, they
would need to be disclosed as such and grouped in the balance sheet with items to
which a similar level of uncertainty applies. Similarly, if changes in assets and
liabilities resulting from such probability calculations are to be recognised in the
statement of financial performance, the level of certainty with which they will be
realised into cash inflows or outflows must be disclosed.
Question 4
Elements for the financial statement(s) of profit or loss and OCI (income and
expense), statement of cash flows (cash receipts and cash payments) and statement of
changes in equity (contributions to equity, distributions of equity and transfers of
equity are briefly discussed in paragraphs 2.37 – 2.52.
14
Do you have any comments on these items? Would it be helpful for the Conceptual
Framework to identify them as elements of financial statements?
Because the IASB Framework is built on the idea that assets are the foundation of
financial reporting, it defines income/gains and expenses/losses as realisable increases
or decreases in assets and liabilities. It regards measurable changes in assets and
liabilities as income and expenses (Par. 2.38). Hence, it does not set out any
recognition or measurement criteria for income (or gains) and expenses (or losses)
and does not consider profit or loss, OCI or total comprehensive income as elements
of financial statements (Par. 2.39).
Mathematically, this argument follows the accounting equation (A – L = E) and
therefore this way of thinking makes sense to those who hold a Proprietary or a
Residual Equity view of corporations as reporting entities. However, defining and
recognising income and expenses as changes in assets and liabilities makes the system
tautological and reduces the information value of the statement of financial
performance. The realisable comprehensive income concept of performance is
implicit in the definition and recognition principles for assets and liabilities.
Depending on the measurement used, this may lead to the inclusion of unrealised
income/gains or expenses/losses in the primary measure of performance. This may be
useful information to some investors, but not to most investors if it is not clear which
income statement elements are realised and which are merely realisable and if not all
unrealised gains and losses are recycled upon realisation.
The DP makes a distinction between revenue and gains and between losses and
expenses but not between realised and unrealised income/gains or expenses/losses
(Par. 2.43 – 2.46). Then it does talk about differentiating between items in profit or
loss and items in OCI (Par. 2.47 – 2.49) but decides to treat this as a matter of
presentation of income and expense items (Par. 2.50) in Section 8 of the DP rather
than as a matter of definition, recognition and measurement of income statement
elements. However, the definitions of assets and liabilities cannot carry the
measurement and recognition of revenues and expenses in the conceptual framework
because the distinction between liabilities and equity is not as clear cut as the IASB
presents it. The DP wishes this distinction were clear because it is based on either the
15
Proprietary or Residual Equity view and has adopted the asset-liability approach to
the determination of income and expenses.
Defining profit or loss, comprehensive income and OCI as well as share capital and
the different elements of surplus would reduce the Framework’s Proprietary Theory
bias.
Question 5
Constructive obligations are discussed in paragraphs 3.39 – 3.62. The discussion
considers the possibility of narrowing the definition of a liability to include only
obligations that are enforceable by legal or equivalent means. However, the IASB
tentatively favours retaining the existing definition, which encompasses both legal
and constructive obligations – and adding more guidance to help distinguish
constructive obligations from economic compulsion. The guidance would clarify the
matters listed in paragraph 3.50.
Do you agree with the preliminary view? Why or why not?
Constructive obligations are probably more in line with Entity Theory and Enterprise
Theory than with Proprietary and Residual Equity Theory, so it depends on which
perspective the IASB adopts. Both legal obligations and constructive obligations will
need to be disclosed separately.
Question 6
The meaning of ‘present’ in the definition of a liability is discussed in paragraphs
3.63–3.97. A present obligation arises from past events. An obligation can be viewed
as having arisen from past events if the amount of the liability will be determined by
reference to benefits received, or activities conducted, by the entity before the end of
the reporting period. However, it is unclear whether such past events are sufficient to
create a present obligation if any requirement to transfer an economic resource
remains conditional on the entity’s future actions. Three different views on which the
IASB could develop guidance for the Conceptual Framework are put forward:
(a) View 1: a present obligation must have arisen from past events and be strictly
unconditional. An entity does not have a present obligation if it could, at least
in theory, avoid the transfer through its future actions.
16
(b) View 2: a present obligation must have arisen from past events and be
practically unconditional. An obligation is practically unconditional if the
entity does not have the practical ability to avoid the transfer through its future
actions.
(c) View 3: a present obligation must have arisen from past events, but may be
conditional on the entity’s future actions.
The IASB has tentatively rejected View 1. However, it has not reached a preliminary
view in favour of View 2 or View 3. Which of these views (or any other view on when
a present obligation comes into existence) do you support? Please give reasons.
Unfortunately, View 1 and View 2 have been framed using a different structure,
which makes them harder to compare. Reframing them so they follow the same
structure would lead to:
View 1: a present obligation must have arisen from past events and be strictly
unconditional. An entity does not have a present obligation if it has the theoretical
ability to avoid the transfer through its future actions.
View 2: a present obligation must have arisen from past events and be practically
unconditional. An entity does not have a present obligation if it has the practical
ability to avoid the transfer through its future actions.
If an entity has the ability to do something in theory, then the entity will have the
ability to do it in practice if its managers, accountants and lawyers set their minds to it.
Therefore, I think that View 2 is a false option. View 3 is another false option. If an
obligation is conditional on the entity’s future actions, how can it be a present
obligation?
If the liability is a present legal obligation View 1 applies. If the liability is a
constructive obligation it is probably not unconditional on the entity’s future actions.
In sum, the definition and recognition of liabilities (and assets) is tricky if the
financial measure of performance is primarily determined as the measurable change in
net assets.
17
Question 7
Do you have comments on any of the other guidance proposed in this section to
support the asset and liability definitions?
Define net assets, surplus and its elements so it is clear what can and cannot be
distributed. Under Residual Equity Theory and Proprietary Theory, a sharp distinction
is crucial because of the asset-liability approach to income determination. Under
Entity Theory and Enterprise Theory, it is not so important if there is a sharp
distinction between liabilities and equity because the determination of distributable
income does not primarily depend on the recognition and measurement of assets and
liabilities. Both approaches have their theoretical and practical strengths and
weaknesses, which is why in an international context it makes more sense to not
choose between them but apply them both.
Question 8
Paragraphs 4.1–4.27 discuss recognition criteria. In the IASB’s preliminary view, an
entity should recognise all its assets and liabilities, unless the IASB decides when
developing or revising a particular Standard that an entity need not, or should not,
recognise an asset or a liability because:
(a) recognising the asset (or the liability) would provide users of financial
statements with information that is not relevant, or is not sufficiently relevant to
justify the cost; or
(b) no measure of the asset (or the liability) would result in a faithful
representation of both the asset (or the liability) and the changes in the asset (or
the liability), even if all necessary descriptions and explanations are disclosed.
Do you agree? Why or why not? If you do not agree, what changes do you suggest,
and why?
Given the fact that the IASB has been working on a revenue recognition project
expected to result in a separate IFRS in the first quarter of 2014, the statement that in
practice questions about recognition and derecognition relate mainly to assets and
liabilities (Par. 4.2), seems to be a typical case of defining the problem out of the
question. Furthermore, the DP suggests deleting all references to probability from the
18
recognition criteria (IASB, 2013: 2.17-2.36 and 4.8) for assets and liabilities. It does
not discuss recognition criteria for revenues and expenses. As reliability has been
replaced by faithful representation (= complete, neutral and free from error), I fear
that it will lead to a situation where anything goes as long as you can defend it using
the faithful representation or relevance (decision-usefulness) argument. More or less
in the same way that the matching concept was taken too far, which led to reserves
and allowances that should never have been recognised in the financial statements.
This opens the door to discretional recognition of revenues, expenses, and both
realised and unrealised gains and losses because of market price changes that have
little to do with the entity’s financial performance from a current operating
perspective because IASB (2010: 4.39) says ‘The interrelationship between the
elements means that an item that meets the definition and recognition criteria for a
particular element, for example, an asset, automatically requires the recognition of
another element, for example, income or a liability.’
Question 9
In the IASB’s preliminary view, as set out in paragraphs 4.28–4.51, an entity should
derecognise an asset or a liability when it no longer meets the recognition criteria.
(This is the control approach described in paragraph 4.36(a)). However, if the entity
retains a component of an asset or a liability, the IASB should determine when
developing or revising particular Standards how the entity would best portray the
changes that resulted from the transaction. Possible approaches include:
(a) enhanced disclosure;
(b) presenting any rights or obligations retained on a line item different from the
line item that was used for the original rights or obligations, to highlight the
greater concentration of risk; or
(c) continuing to recognise the original asset or liability and treating the proceeds
received or paid for the transfer as a loan received or granted.
Do you agree? Why or why not? If you do not agree, what changes do you suggest,
and why?
19
In the examples given, I would support the risk and rewards approach because the
control approach seems to generate perverse incentives to recognise gains or losses
too hastily. I do not think I am able to generalise from these examples though.
Question 10
The definition of equity, the measurement and presentation of different classes of
equity, and how to distinguish liabilities from equity instruments are discussed in
paragraphs 5.1–5.59. In the IASB’s preliminary view:
(a) the Conceptual Framework should retain the existing definition of equity as
the residual interest in the assets of the entity after deducting all its liabilities.
(b) the Conceptual Framework should state that the IASB should use the
definition of a liability to distinguish liabilities from equity instruments. Two
consequences of this are:
(i) obligations to issue equity instruments are not liabilities; and
(ii) obligations that will arise only on liquidation of the reporting entity are
not liabilities (see paragraph 3.89(a)).
(c) an entity should:
(i) at the end of each reporting period update the measure of each class of
equity claim. The IASB would determine when developing or revising
particular Standards whether that measure would be a direct measure, or an
allocation of total equity.
(ii) recognise updates to those measures in the statement of changes in equity
as a transfer of wealth between classes of equity claim.
(d) if an entity has issued no equity instruments, it may be appropriate to treat the
most subordinated class of instruments as if it were an equity claim, with suitable
disclosure. Identifying whether to use such an approach, and if so, when, would
still be a decision for the IASB to take in developing or revising particular
Standards.
Do you agree? Why or why not? If you do not agree, what changes do you suggest,
and why?
a) No. Define net assets, surplus and its elements so it is clear what can and
cannot be distributed and which elements of surplus are more senior or
20
junior when it comes to claims on the entity’s net assets. Local legislation
and the entity’s constitution may be different, but defining net assets as
equity and as a residual when it is not, is misleading.
b) The IASB takes a Proprietary view of the company here. However,
obligations to issue equity instruments are the entity’s liabilities, and
obligations that will arise only on liquidation of the reporting entity are
still the entity’s liabilities. I cannot see them any other way because the
entity’s residual equity holders are protected by limited liability. But then,
as I tend more towards Entity and Enterprise Theory, I do not believe it is
helpful to pretend that there is a strict separation between liabilities and
equity when many financial instruments straddle the two.
c) It seems to me that the Strict Obligation approach is close to Staubus’
Decision-usefulness Theory and Residual Equity Theory because it insists
upon a sharp distinction between liabilities and equity and separates the
financial results for controlling and non-controlling interests. In my
opinion, the wealth transfers referred to in Par. 5.11 – 5.17 are fictional in
a going concern and will be irrelevant when the entity ceases to be a going
concern. The Narrow Equity approach is perhaps more in line with
Proprietary Theory because it is primarily concerned with the common
shareholders’ interests. The Claims approach (Par. 5.51) would perhaps be
more in line with an Entity view of the corporation.
d) If an entity has issued no equity instruments, why would you treat the most
subordinated class of instruments as if it were an equity claim? This
probably has to do with Par. 5.28. Because I do not define assets as
economic resources, I do not define liabilities as the obligation to transfer
economic resources. In my view, a liability is an obligation to transfer a
private property right (or set of private property rights) owned and
controlled by the entity. The obligation to deliver equity instruments
becomes an obligation to transfer a private property right in the entity itself.
By the way, Example 5.1 appears too convenient to me. In order to illustrate an
approach it would be necessary to do this under different scenarios. For example, in
the case that the fair value increases rather than decreases, retained earnings could be
wiped out.
21
Question 11
How the objective of financial reporting and the qualitative characteristics of useful
financial information affect measurement is discussed in paragraphs 6.6–6.35.
The IASB’s preliminary views are that:
(a) the objective of measurement is to contribute to the faithful representation of
relevant information about:
(i) the resources of the entity, claims against the entity and changes in resources
and claims; and
(ii) how efficiently and effectively the entity’s management and governing board
have discharged their responsibilities to use the entity’s resources.
(b) a single measurement basis for all assets and liabilities may not provide the
most relevant information for users of financial statements;
(c) when selecting the measurement to use for a particular item, the IASB should
consider what information that measurement will produce in both the statement of
financial position and the statement(s) of profit or loss and OCI;
(d) the relevance of a particular measurement will depend on how investors,
creditors and other lenders are likely to assess how an asset or a liability of that
type will contribute to future cash flows. Consequently, the selection of a
measurement:
(i) for a particular asset should depend on how that asset contributes to future
cash flows; and
(ii) for a particular liability should depend on how the entity will settle or fulfil
that liability.
(e) the number of different measurements used should be the smallest number
necessary to provide relevant information. Unnecessary measurement changes
should be avoided and necessary measurement changes should be explained; and
(f) the benefits of a particular measurement to users of financial statements need to
be sufficient to justify the cost.
Do you agree with these preliminary views? Why or why not? If you disagree, what
alternative approach to deciding how to measure an asset or a liability would you
support?
22
a) The objective of measurement is not primarily the faithful representation of
relevant information about an entity’s assets, liabilities and changes in assets
and liabilities, and about the efficiency and effectiveness with which the
entity’s management have discharged their responsibilities to use the entity’s
resources. In my opinion, the objective of measurement is to quantify in
monetary term the elements of financial statements so as to enable financial
statements to satisfy the chosen objective(s) of general purpose financial
reporting. See the four views on the objective above. In many jurisdictions,
such quantification serves the determination of income for distribution and
must take into account the capital to be maintained so that it cannot be
distributed as income when it is really the shareholders’ financial capital (to
prevent the nominal capital from hollowing out), or when it is really the
entity’s operating capital (to protect the interests of creditors, lenders and
long-term shareholders). Such quantification also serves the measurement of
financial performance of the entity, on the basis of which the managers’
performance are often assessed and which also forms the input for many other
contracting numbers. Finally, such quantifications also form the input for
models predicting future income and future cash flows or in comparative
analyses of financial position and financial performance.
b) A single measurement method for all assets and liabilities is not possible,
either in theory or in practice.
c) When selecting a measurement method to use for a particular item it is
important to consider the reliability and verifiability of the measurement as
well as the way in which the financial statement element is used in the value
creation process (business model, current/non-current, monetary/non-
monetary) or how it results from this process.
d) Is there a difference between how the entity’s management thinks assets and
liabilities contribute to the creation of value and the generation future cash
flows and how investors make this assessment? Do we know how they make
this assessment?
e) Does this not go without saying?
f) The cost to the residual equity holders? The cost to the entity? The cost to
society? Depends on your normative perspective.
23
Question 12
The IASB’s preliminary views set out in Question 11 have implications for the
subsequent measurement of assets, as discussed in paragraphs 6.73–6.96.
The IASB’s preliminary views are that:
(a) if assets contribute indirectly to future cash flows through use or are used in
combination with other assets to generate cash flows, cost-based measurements
normally provide information that is more relevant and understandable than
current market prices.
(b) if assets contribute directly to future cash flows by being sold, a current exit
price is likely to be relevant.
(c) if financial assets have insignificant variability in contractual cash flows, and
are held for collection, a cost-based measurement is likely to provide relevant
information.
(d) if an entity charges for the use of assets, the relevance of a particular measure
of those assets will depend on the significance of the individual asset to the entity.
Do you agree with these preliminary views and the proposed guidance in these
paragraphs? Why or why not? If you disagree, please describe what alternative
approach you would support.
Relevance is not very well developed in Section 6. The idea appears to be relevance to
the prediction of future cash flows, but what this means and to what kind of prediction
models used by different users and different circumstances this pertains is not clear.
Par. 6.16 – 6.19 give little guidance. The guidance in Par. 6.73 – 6.109 does not
discuss the characteristics of the markets for the assets or liabilities either. It discusses
initial recognition of assets or liabilities arising from exchanges of equal and non-
equal value, non-exchange transactions and internal construction. This appears to
come out of nowhere. It might be helpful to engage with the literature on the types of
transactions that have been identified, for example by Staubus (1961) when he
explained his theory of accounting to investors, or in ASOBAT of ABP No. 4. ABP
No. 4 had adopted a Proprietary perspective that might be close to what the IASB has
in mind, but without proper references, we will never know.
24
The subsequent measurement of assets as articulated in Par. 6.74 – 6.96, talks about
how assets contribute to cash flows, which reminds of the idea of business models,
but is probably meant to apply to individual assets or groups of assets. Similarly, the
subsequent measurement of liabilities is articulated in Par. 6.97 - 6.109.
As I believe that financial statement information must be useful for the four purposes
implied by the four equity theories (stewardship, investment decisions, conflict
resolution and social accountability), the relevance of measurement methods depends
on the purpose at hand. Financial statements could accommodate different
measurements that can be reconciled at a point in time and over different periods, so
that accruals and cash flows always articulate.
a-d) What is the logic or theory according to which these views would apply?
What is the theory of investment decision-making and operations on which
this is based? The Framework’s definition of relevance is too vague to present
any operational guidance. Please present the sources of the theories or ideas
that form the basis of these statements because here they are too vague to
comment on.
Question 13
The implications of the IASB’s preliminary views for the subsequent measurement of
liabilities are discussed in paragraphs 6.97–6.109.
The IASB’s preliminary views are that:
(a) cash-flow-based measurements are likely to be the only viable measurement for
liabilities without stated terms.
(b) a cost-based measurement will normally provide the most relevant information
about:
(i) liabilities that will be settled according to their terms; and
(ii) contractual obligations for services (performance obligations).
(c) current market prices are likely to provide the most relevant information about
liabilities that will be transferred.
25
Do you agree with these preliminary views and the proposed guidance in these
paragraphs? Why or why not? If you disagree, please describe what alternative
approach you would support.
Again, the idea of relevance is not well-developed and seems limited to investment
decisions only. It would need to be defined in four different ways, in accordance with
the different objectives under the four equity theories. Similar to under Question 12,
the logic is not so clearly explained and the source of the theory or theories upon
which it is based is not given. This is not helpful when trying to understand what the
IASB means and how its views are justified.
Question 14
Paragraph 6.19 states the IASB’s preliminary view that for some financial assets and
financial liabilities (for example, derivatives), basing measurement on the way in
which the asset contributes to future cash flows, or the way in which the liability is
settled or fulfilled, may not provide information that is useful when assessing
prospects for future cash flows. For example, cost-based information about financial
assets that are held for collection or financial liabilities that are settled according to
their terms may not provide information that is useful when assessing prospects for
future cash flows:
(a) if the ultimate cash flows are not closely linked to the original cost;
(b) if, because of significant variability in contractual cash flows, cost-based
measurement techniques may not work because they would be unable to simply
allocate interest payments over the life of such financial assets or financial
liabilities; or
(c) if changes in market factors have a disproportionate effect on the value of the
asset or the liability (i.e. the asset or the liability is highly leveraged).
Do you agree with this preliminary view? Why or why not?
Again, the statements above are difficult to comment on because it is not clear where
they come from (sources) and what is the thinking behind them. When measuring
financial instruments and derivatives, in addition to being able to predict the cash
flows associated with these instruments and determine the appropriate discount rates,
26
it is important to know the characteristics of the market in which they are bought and
sold. Do the instruments have subjective value or not?
Question 15
Do you have any further comments on the discussion of measurement in this section?
The discussion of measurement needs to engage with the existing literature, for
example Edwards and Bell (1995, 1961), ASOBAT and ABP No. 4, but particularly
Feltham and Ohlson (1995), Barker (2004) and Penman (2007).
Question 16
This section sets out the IASB’s preliminary views about the scope and content of
presentation and disclosure guidance that should be included in the Conceptual
Framework. In developing its preliminary views, the IASB has been influenced by two
main factors:
(a) the primary purpose of the Conceptual Framework, which is to assist the IASB
in developing and revising Standards (see Section 1); and
(b) other work that the IASB intends to undertake in the area of disclosure (see
paragraphs 7.6–7.8), including:
(i) a research project involving IAS 1, IAS 7 and IAS 8, as well as a review of
feedback received on the Financial Statement Presentation project;
(ii) amendments to IAS 1; and
(iii) additional guidance or education material on materiality.
Within this context, do you agree with the IASB’s preliminary views about the scope
and content of guidance that should be included in the Conceptual Framework on:
(a) presentation in the primary financial statements, including:
(i) what the primary financial statements are;
(ii) the objective of primary financial statements;
(iii) classification and aggregation;
(iv) offsetting; and
(v) the relationship between primary financial statements.
(b) disclosure in the notes to the financial statements, including:
(i) the objective of the notes to the financial statements; and
27
(ii) the scope of the notes to the financial statements, including the types of
information and disclosures that are relevant to meet the objective of the notes
to the financial statements, forward-looking information and
comparative information.
Why or why not? If you think additional guidance is needed, please specify what
additional guidance on presentation and disclosure should be included in the
Conceptual Framework.
The suggested definitions of presentation and disclosure are idiosyncratic and
confusing. In my opinion, presentation means how information is presented on the
face of financial statements and in the notes or supplementary schedules, i.e. layout,
classification, aggregation. There must be reasons for requiring the presentation of
information in one way rather than in another way, and these reasons must be stated in
the Conceptual Framework (I agree with Par. 7.48). Disclosure refers to whether an
item of information is disclosed or not, and if it is disclosed, where it is disclosed and
with what prominence and objective. If it is not disclosed, it must either be proprietary
information or immaterial.
Par. 7.15 and 7.31 is not specific enough. It should talk about the stock statements and
flow statements and the relation between the two under the articulated view, or how
they relate to one another if they do not articulate. How about clean surplus or dirty
surplus?
Par. 7.18 is again not specific enough. Also, as before, I do not agree with the idea
that assets in financial statements represent economic resources.
Question 17
Paragraph 7.45 describes the IASB’s preliminary view that the concept of materiality
is clearly described in the existing Conceptual Framework. Consequently, the IASB
does not propose to amend, or add to, the guidance in the Conceptual Framework on
materiality. However, the IASB is considering developing additional guidance or
education material on materiality outside of the Conceptual Framework project.
28
Do you agree with this approach? Why or why not?
I do not see the need for more guidance on materiality. The concept is well
understood. The application is subjective (Who knows what will influence decisions
made by different users and where to draw the line?) and no amount of additional
guidance will make it less so.
Question 18
The form of disclosure requirements, including the IASB’s preliminary view that it
should consider the communication principles in paragraph 7.50 when it develops or
amends disclosure guidance in IFRSs, is discussed in paragraphs 7.48–7.52.
Do you agree that communication principles should be part of the Conceptual
Framework? Why or why not?
If you agree they should be included, do you agree with the communication principles
proposed? Why or why not?
Communication principles could be useful, but I am not sure that Par. 7.50 has the
right idea because it says that ‘(e)ffective communication reflects the fundamental
qualitative characteristic of representational faithfulness and the enhancing qualitative
characteristics of understandability and comparability’. Effective communication is
indeed understandable, but most importantly, it fulfils its objective. To know whether
or not this is the case, you need feedback from the users or you need to be able to
measure outcomes in other ways. As there are many factors impacting on such
outcomes, this may not be so easy.
Question 19
The IASB’s preliminary view that the Conceptual Framework should require a total
or subtotal for profit or loss is discussed in paragraphs 8.19–8.22.
Do you agree? Why or why not? If you do not agree do you think that the IASB should
still be able to require a total or subtotal profit or loss when developing or revising
particular Standards?
29
Par. 8.38 states that the DP does not choose a primary concept of financial
performance. I believe that this is a big mistake because a concept of financial
performance provides the logic and structure that connects the definition, recognition,
measurement, presentation and disclosure of financial statement elements in an
accounting conceptual framework. Without consciously choosing a primary concept
of financial performance, it will default to comprehensive income where it is not clear
what revenues/gains and expenses/losses have been recognised on a realisable basis or
on the basis of realisation because comprehensive income is the residual. Without
choosing to recycle items of OCI upon realisation, the relation between cash flows
and profit or loss becomes unclear. The IASB Conceptual Framework should define
profit or loss (probably as realised profit or loss), OCI and comprehensive income,
and require profit or loss as a total or subtotal. It must be clear how profit or loss
relates to cash flows through accruals for a financial performance measure to provide
reliable input to valuation models.
Question 20
The IASB’s preliminary view that the Conceptual Framework should permit or
require at least some items of income and expense previously recognised in OCI to be
recognised subsequently in profit or loss, i.e. recycled, is discussed in paragraphs
8.23–8.26.
Do you agree? Why or why not? If you agree, do you think that all items of income
and expense presented in OCI should be recycled into profit or loss? Why or why not?
If you do not agree, how would you address cash flow hedge accounting?
All items in OCI must be reclassified to profit or loss upon realisation. If not, the
reconciliation with cash flows is broken and the allocation problem becomes
permanent until the end of the life of the entity.
The idea in Approach 2A (Narrow approach to OCI) that items need to be included in
profit or loss if and when they enhance the relevance of profit or loss for the period,
and needs to be reclassified when reclassification results in relevant information
requires a very clear definition or idea of what is relevant information. The IASB has
not provided a definition of relevance to the extent necessary for these judgements.
30
The same applies to Approach 2B. They both hinge on a good workable definition of
relevant information, which the Conceptual Framework does not supply, and would
be difficult or even impossible to provide because different decisions by different
users require information that has different attributes.
Question 21
In this Discussion Paper, two approaches are explored that describe which items
could be included in OCI: a narrow approach (Approach 2A described in paragraphs
8.40–8.78) and a broad approach (Approach 2B described in paragraphs 8.79–8.94).
Which of these approaches do you support, and why? If you support a different
approach, please describe that approach and explain why you believe it is preferable
to the approaches described in this Discussion Paper.
Neither. I support the idea that recycling is always required upon realisation. See for
the arguments my answer to question 20.
Question 23
Business model
The business model concept is discussed in paragraphs 9.23–9.34. This Discussion
Paper does not define the business model concept. However, the IASB’s preliminary
view is that financial statements can be made more relevant if the IASB considers,
when developing or revising particular Standards, how an entity conducts its business
activities.
Do you think that the IASB should use the business model concept when it develops or
revises particular Standards? Why or why not? If you agree, in which areas do you
think that the business model concept would be helpful?
Should the IASB define ‘business model’? Why or why not? If you think that ‘business
model’ should be defined, how would you define it?
An entity’s business model expresses the ways it uses cash and non-cash assets,
liabilities, financial and other forms of leverage, and the criteria according to which it
recognises revenues/gains and expenses/losses in order to add value and generate
profits and cash. A business model influences how the entity deals with risk and
uncertainty and hence has an impact on the entity’s direct and indirect stakeholders.
31
Question 24
Unit of account
The unit of account is discussed in paragraphs 9.35–9.41. The IASB’s preliminary
view is that the unit of account will normally be decided when the IASB develops or
revises particular Standards and that, in selecting a unit of account, the IASB should
consider the qualitative characteristics of useful financial information. Do you agree?
Why or why not?
I do not know. I do not understand the explanation of unit of account very well.
Question 25
Going concern
Going concern is discussed in paragraphs 9.42–9.44. The IASB has identified three
situations in which the going concern assumption is relevant (when measuring assets
and liabilities, when identifying liabilities and when disclosing information about the
entity). Are there any other situations where the going concern assumption might be
relevant?
When recognising, measuring, presenting and disclosing the elements of net assets
other than share capital.
Question 26
Capital maintenance
Capital maintenance is discussed in paragraphs 9.45–9.54. The IASB plans to include
the existing descriptions and the discussion of capital maintenance concepts in the
revised Conceptual Framework largely unchanged until such time as a new or revised
Standard on accounting for high inflation indicates a need for change. Do you agree?
Why or why not? Please explain your reasons.
Capital maintenance should be discussed in relation to recognition and measurement
of assets, liabilities, revenues and expenses, and the presentation and disclosure of
shareholders’ equity and profit and loss. Financial capital maintenance (maintaining
the shareholders’ financial capital) goes with Proprietary and Residual Equity Theory.
Maintenance of the entity’s current operating capacity goes with Entity Theory and
Enterprise Theory.
32
The Reporting Entity
The 2010 Exposure Draft on the Reporting Entity included the following three
questions for respondents that are still relevant to this DP:
1. Do you agree that a reporting entity is a circumscribed area of economic
activities whose financial information has the potential to be useful to existing
and potential equity investors, lenders and other creditors who cannot directly
obtain the information they need in making decisions about providing
resources to the entity and in assessing whether the management and the
governing board of that entity have made efficient and effective use of the
resources provided? If not, why?
2. Do you agree that if an entity that controls one or more entities prepares
financial reports, it should present consolidated financial statements? Do you
agree with the definition of control of an entity? If not, why?
3. Do you agree that a portion of an entity could qualify as a reporting entity if
the economic activities of that portion can be distinguished from the rest of the
entity and financial information about that portion of the entity has the
potential to be useful in making decisions about providing resources to that
portion of the entity? If not, why?
1) No. This definition is too vague and limited because of its focus on decision-
usefulness. The other three main functions of financial reporting require a
definition of a reporting entity that recognises how financial reporting is a
means to reduce agency costs arising from agent-principal problems between
the entity’s shareholders and its senior management, and the weaknesses of
boards of directors in balancing the interests of all the corporation’s
stakeholders as well as the stakeholders in the capital markets system (i.e. the
general public). The definition of a reporting entity needs to be cognizant of
the nature and structure of the reporting entity and the relations with its
various stakeholders, not only its direct financial stakeholders.
2) I believe that each corporate legal entity should prepare and disclose a full set
of independent financial statements and that, in addition, a combination of
corporate legal entities under single control should present a full set of
consolidated financial statements.
33
3) I don’t understand the question. Who decides what is useful to whom? The
IASB?
References
Barker, R. (2004) Reporting Financial Performance. Accounting Horizons, 18 (2):
157-172.
Black, F. (1993) ‘Choosing Accounting Rules’ Accounting Horizons 7 (1): 1-17.
Cearns, K., Australian Accounting Standards Board, Canadian Accounting
Standards Board, International Accounting Standards Committee, New Zealand
Financial Reporting Standards Board, United Kingdom Accounting Standards
Board, United States Financial Accounting Standards Board (1999) Reporting
Financial Performance: proposals for change (G4 + 1 Position Paper).
(http://www.frc.org.uk/Our-Work/Publications/ASB/Reporting-Financial-
Performance-Proposals-for-Chan.aspx, (accessed 11 March 2013))
Edwards, E.O. & Bell, P.W. (1995, 1961) The Theory and Measurement of Business
Income. New York and London: Garland Publishing.
Feltham, G.A. & Ohlson, J.A. (1995) Valuation and Clean Surplus Accounting for
Operating and Financial Activities. Contemporary Accounting Research, 11 (2): 689-
731.
Financial Accounting Standards Board (1978) Statement of Financial Accounting
Concepts No. 1
International Accounting Standards Board (2010)
Penman, S. (2007) Financial reporting quality: is fair value a plus or a minus?
Accounting and Business Research, Special Issue: 33-44.
Sprouse, R. T. (1957), ‘The Significance of the Concept of the Corporation in
Accounting Analyses’ The Accounting Review, 32(3), pp. 369-378.
Sprouse, R.T. (1976), The Effect of the Concept of the Corporation on Accounting,
New York: Arnold Press.
Staubus, G. J. (1959) ‘The Residual Equity Point of View in Accounting’ The
Accounting Review, 34(1), pp. 3-13.
Staubus, G. J. (1961) A Theory of Accounting to Investors, Berkeley and Los
Angeles: University of California Press.
Staubus, G.J. (1999) The Decision-Usefulness Theory of Accounting: A Limited
History, New York and London: Garland Publishing Inc.
Suojanen, W. W. (1954) ‘Accounting Theory and the Large Corporation’ The
Accounting Review, 29(3), pp. 391-398.
Suojanen, W. W. (1958) ‘Enterprise Theory and Corporate Balance Sheets’ The
Accounting Review, 33(1), pp. 56-65.
34
Van Mourik, C. (2010) ‘The Equity Theories and Financial Reporting: An Analysis’
Accounting in Europe, 9 (2), pp. 191-211.
Van Mourik, C. (2013a) ‘Fundamental Issues in Financial Accounting and Reporting
Theory’ in Van Mourik & Walton (eds) The Routledge Companion to Accounting,
Reporting and Regulation, UK, Abingdon: Routledge.
Van Mourik, C. (2013b) ‘The Public Interest in International Financial Accounting,
Reporting and Regulation’ in Van Mourik & Walton (eds) The Routledge Companion
to Accounting, Reporting and Regulation, UK, Abingdon: Routledge.
Zeff, S.A. (1978), A Critical Examination of the Orientation Postulate in Accounting
With Particular Attention to its Historical Development, New York: Arno Press.