0,~ DEVELOPING A CONCEPTUAL FRAMEWORK
3. Initially consider concepts applicable to private sector business entities. Later, the Boards will jointly consider the applicability of those concepts to private sector
not-for-pro fit organisations. Representatives of pub lie sector (governmental) standard- setting Boards are monitoring the project and, in some cases, considering the potential consequences of private sector deliberations for public sector entities.21
The boards are conducting the joint project in eight phases. Each of the first seven phases will address and involve planning, research, initial Board deliberations, public comment, and redeliberations on major aspects of the Boards' frameworks. The phases are shown in figure 4.4.
Pha..,e Topic
A Objective and Qualilative Characteristics B Elements and Reco~lion
, - - - -
- -
C Measurement
D Reporting Entity
- - - - -
E Presentation and Disclosure, including Financial Reporting Boundaries
(Inactive)
F Framework Purpose and Status in GAAP Hierarchy (Inactive)
G Applicabilil)' to the Not-for-Prc,_fit_?ector (lna_ctive)
---
- -
----H Remaining Issues (Inactive)
FIGURI: 4.4 IASB/FASB Conceptual Framework Project
Sourn~: Concep!tl<ll fr,1mework Joint ProjPCI ol the !ASB ,111d r /\SB, project in!onn;:ition page, www.f;isb.org.
For each phase, the Boards plan to issue documents that will seek comments from the public on the Boards' tentative decisions. The Boards will consider these comments and redeliberate their tentative decisions. While the Boards plan to seek comments on each phase separately, they have not precluded seeking comments on several phases concurrently.22 By 30 June 2009 the Boards had issued and received comments on an exposure draft (ED) relating to Phase A Objectives and Qualitative Characteristics. A discussion paper relating to Phase D Reporting Entity had been issued and work was continuing on Phase B Elements and Recognition and Phase C Measurement.
The decision to defer consideration of not-for-profit sector issues has been contentious. In countries such as Australia and New Zealand, which follow a 'sector- neutral' approach to standard-setting issues relating to the not-for-profit sector need to be addressed at the same time the concepts are developed for the for-profit sector.
(A sector-neutral approach means that the same standards are applied in the public, not-for-profit and private sectors). Feedback from national standard setters (from Australia, New Zealand, Canada and the UK) has suggested three areas where current Board deliberations raise issues for the not-for-profit sector.
They are:
• an insufficient emphasis on accountability and stewardship
• a need to broaden identified users and establish an alternative primary user group
• the inappropriateness of the pervasive cash flow focus.23
McGregor and Street24 state that the IASB has some sympathy for the arguments advanced by constituents. However, extending the scope of the conceptual framework project at this time to include not-for-profit entities will increase the work load of the Boards and expose the project to the risks of further time delays and greater difficulty
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in reaching decisions. In an interesting development, whid1 challenges the JASB's rocus on the for-profit sector, the IFAC's International Public Sector Accounting Standards Board (IPSASB) has began a project to develop a conceptual framework for the public sector entities. The objective of the project is to develop a Public Sector Conceptu,il Framework whim is applicable to the preparation and presentation of general purpose financial reports of public sector entities. A discussion paper was released in September 2008.25 Case study 4.2 at the end of this rnapter focuses on financial reporting in the not-for-profit sector. Specifically, it allows students to consider the quality of financial reporting in this sector using reporting guidelines proposed by a professional accounting body (the Institute of Chartered Accountants in Australia, or ICM).
Comments on the Phase A exposure draft (ED) identify several key issues for stakeholders. Whittington26 states that these issues were considered to be uncontroversial, but this has not proved to be the case. The ED discussion adds to material in the existing IASB Framework (i.e. its form and argument) and brings it under the scrutiny of stakeholders who were not involved in the development of the 1989 Framewo,·h.
Controversial matters include the perspective underlying financial reporting ( entity vs proprietorship), the primary user group and the objective of financial reporting, and the qualitative characteristics of financial reporting. Each of these issues is discussed below.27
Entity vs proprietorship perspective
As discussed later in this book, the entity and proprietorship perspectives represent different approaches to financial reporting. The Boards recommended that financial reports should be prepared from the perspective of the entity rather than the perspective of the owners or a particular class of owners. Many respondents agreed that the entity is distinct from its owners and thus concurred with reporting from the perspective of the entity. Others noted that the notion of reports being produced from an entity perspective was being introduced for the first time (i.e. it was not part of previous frameworks) and that the boards did not provide enough information to justify the choice of the entity perspective over other perspectives ( such as the proprietorship and parent company perspectives). The perspective adopted is important as it affects work in Phase D, Reporting entity, where alternative perspectives are under discussion.28
Primary user group
The Boards proposed that the primary user group for general purpose financial reporting is present and potential capital providers. Most respondents agreed with the Boards' approach that present and potential capital providers ( equity investors, lenders and other creditors) of the entity are the primary user group. However, it was noted that having a diverse primary group could oversimplify the relationship between the entity and individual users. Other respondents were concerned about the focus on a primary user group and the effect this could have on recognition of needs of other parties, such as charities and corporate governance monitoring groups.
Decision usefulness and stewardship
According to the Boards, the objective of financial reporting should be 'broad enough to encompass all the decisions that equity investors, lenders, and other creditors make in their capacity as capital providers, including resource allocation decisions as well as decisions made to protect and enhance their investments'.29 Many respondents agreed with the Boards' view. However, many other respondents were concerned that
CHAPTER 4 A conceptual framework 109
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the objective of stewardship is not sufficiently emphasised, while the role of financial statements in providing information to enable users to forecast future cash flows is overemphasised. For example, a group representing European national standard setters produced a report specifically addressing stewardship/accountabilty as an objective and concluded that there is broad consensus in support of stewardship/accountability as a separate objective of financial reporting. 30
Whittington considers that the objective of stewardship has been 'sidelined' in the ED and notes that this is not acceptable to many constituents, particularly in Europe, where stewardship is a key part of corporate governance and company regulation. 31 He states that stewardship has been subsumed into the decision usefulness objective in the ED. However, it can be argued (and was argued by some JASE Board members during discussions of the issue) that accountability entails more than the prediction of cash flows and that stewardship is about monitoring the past as well as predicting the future cash flows. It may be as much concerned with integrity of management as with economic performance.
Qualitative characteristics
The IASB Framework includes four principal qualitative characteristics, namely understandability, relevance, reliability and comparability (paragraphs 24-42). The exposure draft proposes that the qualitative characteristics that make information useful are relevance, faithful representation, comparability, verifiability, timeliness and understandability; and that the pervasive constraints on financial reporting are materiality and cost. The qualitative characteristics are distinguished as either fundamental ( relevance, faithful representation) or enhancing ( comparability, verifiability, timeliness and understandability), depending on how they affect the usefulness of information.
Nearly every respondent commenting on the ED agreed that relevance is a fundamental characteristic. A majority agree in relation to faithful representation, but suggested the Boards have not adequately justified replacing reliability with faithful representation and that the terms have different meanings. Whittington notes that the 1989 Framework allowed for a trade off between relevance and reliability but the ED fails to acknowledge that relevance and faithful representation are relative not absolute properties of accounting information.32 He considers that this approach has implications for practice: relevance will be considered first, followed by representational faithfulness, rather than allowing for a trade-off which recognises the relative importance, in the particular situation, of the each characteristic. Penna argues that an accounting conceptual framework must aclmowledge the necessity of what he describes as 'vagueness' in its terms.33 The difficulty in capturing concepts in the terms used in the Framework and the implications which follow from the use of particular terms is well-illustrated in the following IASB discussion about reliability and faithful representation:
Although some Board members were cautious about losing the term 'reliable' from the general IFRS lexicon, otl1er Board members and IASB senior staff noted fuat 'reliable' was one of the most problematic terms in that lexicon. Some used it to imply precision;
others used it as an excuse to avoid recognising liabilities; others to imply verifiability.
The Board concluded that the only way to avoid this misuse and the consequent miscommunication was to focus on what the Framework was trying to communicate was to use a different term. 'Faithful representation' was perhaps not the ideal term, but it was the best they had.34
Not surprisingly, many people suggested changes to the qualitative characteristics listed in the ED. Respondents suggested that understandability and verifiability
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be elevated, as well ~s the addition of prudence or concepts sud1 as substance over form, true and fair view, and transparency, The ED rejects the concepL of prudence as inconsistent with neutrality (which is freedom from bias). Some constitucnLs, for whom stewardship is an important objective, may be uncomfortable with removin , prudence. Whirtington queries the removal of prudence as a qualitative characteristi;
because of its importance in restraining managerial opponunism.35 In addition, he claims the concept is still actively used by the IASB, for example in a recent standard
!AS 36 Impairment (i.e. recognise impairment losses but not increases in asset values).
The boards are continuing their work on Phase B and Phase C Measurement. In relation to Phase B, the existing definition of the elements of financial reporting ( assets, liabilities, equity, revenue and expense) are being modified and new recognition criteria are being proposed.36
As noted earlier, prior conceptual frameworks have struggled to deal effectively with the issue of measurement. For the same reasons, Phase D will be controversial.
Whittington notes that given the current reality of financial reporting, the pursuit of one universal measurement method may be fruitless.37 He suggests that a more appropriate approach could be to define a clear measurement objective and to select Lhe measurement method that best meets that objective in the particular circumstances that exist in relation to each item in the accounts.
The IASB and l'ASB need to make progress on the conceptual framework as it is fundamental to developing standards and it underpins convergence efforts. Case sLudy 4 .3 at the end of this chapter provides an opportunity to consider further the issues raised in this chapter in relation to the IASB/FASB conceptual framework projecL The boards need some measure of consensus and support about objectives of financial reporting and qualitative characteristics of financial information to be able to issue framework chapters that are acceptable to constituents. Feedback comments represent many individual perspectives and views about key attributes of information, which relate back to individual views about the purpose of accounting information. We have seen that stakeholders are making their views known through the consultation process.
The project has many challenges ahead and it is a test of whetl1er parties can seL aside individual differences to achieve the goal of harmonisation of financial reporting.