Conceptual framework for financial reporting Exposure draft ED/2015/3 of a revised framework issued by the International Accounting Standards Board in May 2015

Comments from ACCA25 November 2015

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Further information about ACCA’s comments on the matters discussed here may be obtained from the following:

Richard MartinHead of Corporate Reporting, ACCAEmail: richard.martin@accaglobal.com

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ACCA welcomes the opportunity to provide comments on the exposure draft (ED) of a revised conceptual framework. This has been done with the assistance of the members of ACCA’s Global Forum for Corporate Reporting who have considered the questions raised, and their views are reflected in the following comments.

MAIN COMMENTSThe conceptual framework (CF) is an important document. While not a standard in itself to be complied with it should help to shape future standard setting by the IASB by ensuring greater consistency and coherence in the process. In some circumstances those preparing and auditing accounts may need to refer to it to help them.

We support the proposed framework in most respects.

Our reservations are set out in the answers below to the specific questions raised in the ED and principally are as follows.

Prudence should not be included in the CF as part of neutrality in terms of the preparation of financial statements. The two concepts seem to be too different and there is a risk that prudence will be selectively applied by preparers to ‘manage’ their reported financial information.

The potential for asymmetric recognition in standard-setting, however, of assets and liabilities and gains and losses referred to in the basis for conclusions needs to be part of the CF itself.

A clear principle is needed for definition of the reporting entity, so that when combined financial statements are produced there are some concepts to guide their use.

The equity method of accounting is not covered by the draft CF, despite being used in the standards themselves. The concept needs to be included and identified either as an extension of the

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consolidation concept in Chapter 3, or as a measurement basis in Chapter 6.

Certain conceptual issues are currently inadequately addressed in this ED – specifically the distinctions between liabilities and equity in one case and that between profit and other comprehensive income (OCI) as the other. IASB has chosen that these are progressed as standard setting projects. If so they need to be progressed with high priority and then the concepts that are settled on need to be included in a timely revision of the CF. In our view the current incoherent treatment of OCI is one of the most significant weaknesses in IFRS.

The question of recycling of items from OCI to profit or loss needs to be addressed not as a rebuttable presumption but as a question of relevant and understandable information for users and the criteria to guide that decision set out in the CF.

Chapter 8 on capital maintenance is currently inconsistent with the rest of the CF and should be removed for now and reconsidered.

SPECIFIC COMMENTS ON QUESTIONS RAISED Question 1—Proposed changes to Chapters 1 and 2Do you support the proposals:(a) to give more prominence, within the objective of financial reporting, to theimportance of providing information needed to assess management’sstewardship of the entity’s resources;

(b) to reintroduce an explicit reference to the notion of prudence (described as caution when making judgements under conditions of uncertainty) and to state that prudence is important in achieving neutrality;

(c) to state explicitly that a faithful representation represents the substance of an economic phenomenon instead of merely representing its legal form;

(d) to clarify that measurement uncertainty is one factor that can make financial information less relevant, and that there is a trade-off between the level of measurement uncertainty and other factors that make information relevant; and

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(e) to continue to identify relevance and faithful representation as the twofundamental qualitative characteristics of useful financial information?Why or why not?

(a) We agree with the importance of the stewardship objective, but consider that it in the conceptual framework (CF) it should be an objective for financial reporting on an equal footing with providing information for economic decisions.

(b) We do not agree with how prudence has been dealt with in paragraph 2.18.

The way it has been stated there prudence is a quality (caution in the face of uncertainty) which should be followed in the preparation of financial statements. This approach risks encouraging earnings management by apparently giving companies the freedom to reduce profits by applying ‘prudence’ in the preparation of their accounts when that is convenient. Prudence also seems inherently inconsistent with neutrality and so cannot be incorporated within that concept.

When there is significant uncertainty with regards to an asset or liability then that should be properly reflected in the risk premium or adjustment that is made in reaching either an assessment of any impairment of a historical cost element or one at fair value. The uncertainty must be incorporated to achieve an unbiased measurement. It is often the case that external parties in valuing assets and liabilities may place more weight on downside rather than on upside risks.

However the CF is principally an aid to the IASB to help set standards that are coherent and achieve the right objectives, rather than a guide to preparers. We see an important role for what could be termed prudence in standard setting, particularly in the possibility that there should in some cases be asymmetric recognition of assets and liabilities and gains and losses.

This asymmetrical prudence can be seen in the standards themselves, for example in the treatment of onerous and executory contracts (IAS37), contingent assets and liabilities (IAS37), deferred tax assets and liabilities (IAS19) and in variable consideration in IFRS15. However in other cases such as financial instruments there is basically no asymmetric recognition.

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This possibility of asymmetry is confirmed in the basis of conclusion but being so self-evidently important in standard setting it should be dealt with in the CF itself, as a possibility (not a necessity) in Chapter 1 and under recognition criteria in Chapter 4.

We agree with proposed treatment of significant measurement uncertainty. We note above that uncertainty otherwise should be reflected by preparers in valuations via the proper reflection of risk. Beyond that we see less of a role for specific prudence to be applied by the IASB in setting the measurement requirements in IFRS.

(c) We agree with the specific reference to substance over form. We suggest that the word ‘merely’ is replaced by ‘only’.

(d) As noted above we agree with the treatment of measurement uncertainty.

(e) We agree with relevance and faithful representation as the fundamental characteristics of useful financial information. We agree that faithful representation is a better term than reliability in the sense that it seems to capture more of the ‘presents fairly’ or ‘true and fair’ concept.

Question 2—Description and boundary of a reporting entityDo you agree with:(a) the proposed description of a reporting entity in paragraphs 3.11–3.12; and(b) the discussion of the boundary of a reporting entity in paragraphs 3.13–3.25?Why or why not?

There is no clear principle for determining the reporting entity. Control (direct and indirect) is discussed in terms of the boundary of the reporting entity. We are content that further elaboration of control is left to standards such as IFRS10. However joint control and significant influence are not discussed and that seems a significant omission in the CF given their appearance in two standards. Some may see the concepts as partially extending the reporting entity to include joint ventures and associates.

The issue of the lack of a clear definition of the reporting entity also arises in terms of combined financial statements. We are pleased that the concept

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and possibility of combined financial statements is included in the CF, with its implicit confirmation that combined financial statements could comply with IFRS. However with no principles in determining the reporting entity this leaves the field wide open as to what entities could be combined. Paragraph 3.11 simply says that a reporting entity could be one that “chooses to prepare general purpose financial statements”.

The CF is mainly to assist the IASB in setting standards but as there is no IFRS for combined financial statements then preparers following IAS8.10 hierarchy may be looking to the CF for guidance in this area and so this lack of guidance or restriction is particularly significant.

Paragraph 3.20 could be read to imply that separate financial statements should always be prepared along with consolidated ones. That would seem a step too far and in contradiction to existing standards.

In our view 3.23 is not helpful and would be better deleted. The usefulness of unconsolidated compared to consolidated financial statements depends on the purpose for which they are being used.

Chapter 3 refers to unconsolidated financial statements whereas IAS27 refers to separate financial statements and consistency in terminology here would help.

Question 3—Definitions of elementsDo you agree with the proposed definitions of elements (excluding issues relating to the distinction between liabilities and equity):(a) an asset, and the related definition of an economic resource;(b) a liability;(c) equity;(d) income; and(e) expenses?Why or why not? If you disagree with the proposed definitions, what alternative definitions do you suggest and why?

We agree with the definitions of assets and liabilities. They are clearer than the current ones and they should exclude the probability element. We also agree with definitions that depend on them – that is equity, income and expenses.

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We note that the definition of assets is broad and would encompass a number of items that would not be included in the current definition and therefore the recognition criteria are particularly important.

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Some more detailed comments are: In 4.10 access to public goods are an economic resources for an

entity, but they are not assets because they are not controlled by the entity. This would be more in line with the concepts of capital in Integrated Reporting for example.

We are not sure that 4.25 is very helpful with its implicit requirement of symmetry between different parties. It could be deleted without affecting 4.26 for example.

There is also more supporting material needed for the definition of liability.

Question 4—Present obligationDo you agree with the proposed description of a present obligation and the proposed guidance to support that description? Why or why not?

There is explanation in 4.32 to 4.35 of this condition ‘no practical ability to avoid a transfer’, but some aspects should be more definitively dealt with. Liabilities contingent on the future actions of others would generally be recognised, but those dependent on the entity’s own action would only be where the ‘no practical ability’ test would be applied. 4.32 talks about business disruption or adverse economic consequences, but there is a scale from probable economic advantage to economic compulsion that needs to be addressed.

In terms of a past event the concept of the ‘stand ready’ obligation should be covered.

4.31(a) refers to the receipt of economic benefits and we think that in some cases that should be an important factor in deciding whether a liability exists.

Question 5—Other guidance on the elementsDo you have any comments on the proposed guidance? Do you believe that additional guidance is needed? If so, please specify what that guidance should include.

Given the significance of cash flows both in the determination of useful information and in the importance of the cash flow statement, it seems a significant omission that the elements defined in the CF do not include cash inflows and outflows.

We note that the CF does not set out any further principles for the boundary between what are equity instruments and what are liabilities. This is intended

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to be the subject of a standards level project, but when those principles are established they need to be incorporated into the CF.

No further comments.

Question 6—Recognition criteriaDo you agree with the proposed approach to recognition? Why or why not? If you do not agree, what changes do you suggest and why?

We agree with the approach to recognition of setting out criteria to consider without determining the balance between them. In applying these criteria the IASB will need to be careful to try and minimise inconsistencies between the standards that might result.

We have noted above our concern that the possibility in some cases of asymmetrical recognition of assets compared to liabilities, and of gains compared to losses needs to be reflected in the discussion of recognition criteria.

Paragraph 5.13(a) refers to the existence of assets and its separability from goodwill. Arguably this separability should therefore be part of the definition of an asset.

Question 7—DerecognitionDo you agree with the proposed discussion of derecognition? Why or why not? If you do not agree, what changes do you suggest and why?

We agree with the discussion of derecognition. Currently some standards employ a control model and others (such as for financial instruments) a risk and reward approach. Both are included as 5.25 and 5.29 respectively.

Question 8—Measurement basesHas the IASB:(a) correctly identified the measurement bases that should be described in the Conceptual Framework? If not, which measurement bases would you include and why?(b) properly described the information provided by each of the measurement bases, and their advantages and disadvantages? If not, how would you describe the information provided by each measurement basis, and its advantages and disadvantages?

We agree that the two main categories of measurement bases are historical cost and current values. However the implication of this for measurement

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bases that do not appear to fit under either of these is not clear, for example the equity basis of measurement (for associates and JVs). The lack of reference to joint control or significant influence noted in response to Q2 above makes this of greater importance.

6.23 The discussion could make clearer that fair value reflects future cash flows except for transaction costs. The CF might note that sometimes transaction costs are not separated but are reflected in the bid-offer spread.

Question 9—Factors to consider when selecting a measurement basisHas the IASB correctly identified the factors to consider when selecting a measurement basis? If not, what factors would you consider and why?

We agree with the factors identified, especially the two in paragraph 6.54. The CF could spell out the implications of these, in terms of which business models are more likely to lead to current values and which more likely to lead to cost-based measures.

Question 10—More than one relevant measurement basisDo you agree with the approach discussed in paragraphs 6.74–6.77 and BC6.68? Why or why not?

There may be cases where, using the criteria of relevant information, the profit or loss treatment might be best on a historical cost basis and yet the balance sheet should incorporate a current value. However such treatments do go against the basic model of the connection of income statements and balance sheets and can add significant complexity (see our comments in response to Q13 and Q14). So such solutions should not be readily employed.

Question 11—Objective and scope of financial statements and communicationDo you have any comments on the discussion of the objective and scope of financial statements, and on the use of presentation and disclosure as communication tools?

We agree with what is included in these sections..Question 12—Description of the statement of profit or lossDo you support the proposed description of the statement of profit or loss? Why or why not?

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If you think that the Conceptual Framework should provide a definition of profit or loss, please explain why it is necessary and provide your suggestion for that definition.

We agree with the description of the profit or loss as the primary source of information about the entity’s financial performance. We recognise it as a long standing and the most widely used measure of performance. For this reason it would be better if the CF included a positive definition. However we accept that for now it is difficult to provide that.

In the absence of such a definition then we agree with the default position being that all income and expenses are reported in profit or loss, unless required or allowed by an IFRS to be included in OCI.

The basis for conclusion includes a reference to the restriction that only the IASB can allow the OCI treatment. Occasionally preparers will need to use the CF in the absence of an applicable IFRS, so it is important that this restriction is in the CF itself and not in the basis for conclusions.

Question 13—Reporting items of income or expenses in other comprehensiveincomeDo you agree with the proposals on the use of other comprehensive income? Do you think that they provide useful guidance to the IASB for future decisions about the use of other comprehensive income? Why or why not?If you disagree, what alternative do you suggest and why?

We consider that more emphasis in the CF should be given to developing a useful presentation of the statement of comprehensive income as a whole and less to the separation of OCI from profit and loss. What is most important is that there is transparency for the readers of the financial statements of the different components of comprehensive income. In the end the stewardship objective means that management are accountable for comprehensive income and not just what is in profit and loss. IASB should be looking more to encouraging helpful analysis of all of the components of comprehensive income, to try to identify for users items that are likely to be persistent and have more implications for the trend of future performance from those that may be ‘one off’.

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As noted above we consider it would be better for the CF to have a positive definition of profit, although we recognise that this is difficult to achieve at present. If there can be no positive definition of profit for the period then we accept there cannot be one of OCI either. Paragraph 7.24 sets out the criteria for IASB to decide when an item could be reported in OCI. We do not object to either (a) or (b) but think they are too imprecise to form an adequate basis for such decisions to be taken on a consistent and coherent basis. In particular 7.24(b) needs the criteria set out which will be used to judge the relevance of the information referred to.

Furthermore the conditions in 7.24 are not framed positively, so they are criteria for possible inclusion in OCI, not for deciding whether something should in principle be included in OCI.

The current incoherent picture of OCI treatments is one of the most significant weaknesses in current IFRS and one where the CF is expected to point the way. This proposed version of the CF does not progress sufficiently in that direction. We consider that this profit or loss/OCI issue needs more research by IASB in different presentations and an overall reconsideration of performance presentation generally including revising IAS1 and IFRS8.

Question 14—RecyclingDo you agree that the Conceptual Framework should include the rebuttable presumption described above? Why or why not?If you disagree, what do you propose instead and why?

We do not agree with the rebuttable presumption proposed that all items in OCI should ultimately be recycled, but consider that there should be no presumption either way. The CF should set out the criteria that will be considered in reaching a decision in a standard on whether there should be recycling. Recycling of elements that have formed part of OCI increases the complexity of the financial statements and may in some cases reduce the relevance and understandability of the profit and loss statement. We see the need for recycling for cash flow hedging instruments, but believe that to be a special case.

As noted above in general there should be more emphasis on comprehensive income rather than on its separation into two components.

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Question 15—Effects of the proposed changes to the Conceptual FrameworkDo you agree with the analysis in paragraphs BCE.1–BCE.31? Should the IASB consider any other effects of the proposals in the Exposure Draft?

We do not disagree with the analysis provided, but we think that it is incomplete.

We agree that IFRIC21 and potentially IAS37 itself may not be consistent with the definitions of liabilities included in the CF. Likewise the distinction between debt and equity in IAS32 would not be consistent. We note that IASB is contemplating or already working on projects that would reconsider those standards.

However we find that the differences analysed are incomplete and that there are potentially more standards that will be inconsistent. For example in our answer to Q8 above we highlight that the equity accounting approach in IFRS11 and IAS28 appears to be inconsistent with the CF. Other examples might be the lack of discounting of deferred tax liabilities or the assets and liabilities in accounting for government grants.

Question 16—Business activitiesDo you agree with the proposed approach to business activities? Why or why not?

We would prefer the CF used the term ‘business model’ to ‘business activities’. ‘Business model’ is used to mean a variety of things in a general context. However it is better at capturing the idea of how value is created by the reporting entity and would come to have a more specific and narrower meaning in reporting standards. It is also the term already used in IFRS9 and in other forms of reporting such as Integrated Reporting. ‘Business activities’ on the other hand is a vaguer term and could simply mean the economic sectors where the entity operates.

The implications of different business models are addressed in the different Chapters of the CF, for example on presentation, measurement and the unit of account. It will also be needed for Chapter 7 and the OCI issue (see Q14 above). Given that we think that the CF should include an overall discussion of the business model and its significance.

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Question 17—Long-term investmentDo you agree with the IASB’s conclusions on long-term investment? Why or why not?

We agree with the conclusions of the IASB that long term investors can be served by the current formulation of the CF.

Question 18—Other commentsDo you have comments on any other aspect of the Exposure Draft? Please indicate the specific paragraphs or group of paragraphs to which your comments relate (if applicable).As previously noted, the IASB is not requesting comments on all parts of Chapters 1 and 2, on how to distinguish liabilities from equity claims (see Chapter 4) or on Chapter 8.

In our view the inclusion in 1.6 of the other sorts of information that might be needed should be improved. There has been a general reassessment of the importance of non-financial information in corporate reporting to which the CF should respond. The Integrated Reporting is one such indication of the wider perspective that is needed. IASB’s own Management Commentary guidance points to different factors than are currently included in 1.6.

Chapter 8 introduces the concept of capital maintenance adjustments, however these are not included among the elements discussed in Chapter 4 nor appear on the diagram at 5.6 for example. In 8.4 such adjustments are regarded as expenses, but in 8.8, 8.9 and 8.10 they seem to be specifically excluded from being expenses. They therefore undermine the main model.

Furthermore the non-application in IFRS of the concepts of capital maintenance needs to be made clearer than it is in 8.9. Capital maintenance adjustments as far as we are aware are not being specifically required in IFRS at present.

For both these reasons we think the whole of Chapter 8 would be better removed from the CF for now and reconsidered.

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