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Response to the IASB’s DP/2015/3 Conceptual Framework for

Financial Reporting

15 October 2015, Carien van Mourik, carien.vanmourik@open.ac.uk

Open University Business School, Walton Hall, Milton Keynes, UK, MK7 6AA

Introduction

Firstly, I would like to make it clear that I wholeheartedly support the idea of

developing a single set of financial reporting standards based on a clearly articulated

and coherent set of concepts that is used globally. International standardisation of

accounting standards makes sense from an efficiency, comparability and cost

perspective for standard setters, multinational and international corporations, global

and international investors in equity and debt securities, preparers, analysts, auditors,

investors, teachers and researchers.

Secondly, I believe that the IABS Conceptual Framework is an extremely important

document for the following reasons.

As the conceptual basis intended to underpin IFRS, the IASB Conceptual

Framework has the potential to impact on the general international public

interest for better or for worse.

The IASB Conceptual Framework helps preparers and auditors to interpret

IFRS and the spirit of the standards in applying them.

The IASB Conceptual Framework is being taught by professional accounting

bodies and in some universities as financial accounting and reporting theory.

Therefore, it influences how existing and new generations of managers,

investors, investment advisors, CEOs, CFOs, accounting students, auditors

and other accounting professionals and even accounting academics think about

accounting models and financial accounting and reporting theory in relation to

the international public interest.

Unfortunately, I do not entirely share the IASB’s interpretation of the public interest

as set out in the Constitution, the Mission Statement and the Conceptual Framework. I

do not believe that a Conceptual Framework that prioritises the interests of

multinational corporations and global investors is necessarily in the interest of the

general public across the 116 jurisdictions that have adopted IFRS in some form or

another. These jurisdictions comprise different institutional and regulatory

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environments that have different levels of financial and capital market development,

regulation, enforcement, and protection of private property rights, and different ways

in which institutional complementarities compensate for externalities inflicted upon

the general public. By subsuming the stewardship objective under the decision-

usefulness objective of general purpose financial reporting rather than giving the

stewardship objective equal prominence, the IASB biases the Conceptual Framework

and IFRS towards capital market participants in countries with institutional

characteristics similar to those aspired to by the USA in the 1970s (See SFAC No. 1).

Below I will answer most of the questions, but there are some questions I am not able

comment on. In response to question 18 I will provide my general comments and

reservations.

Question 1 - Proposed changes to Chapters 1 and 2

Do you support the proposals:

(a) to give more prominence, within the objective of financial reporting, to the

importance of providing information needed to assess management’s

stewardship of the entity’s resources;

(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

(e) to continue to identify relevance and faithful representation as the two

fundamental qualitative characteristics of useful financial information?

Why or why not?

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a)

Giving stewardship more prominence by simply mentioning it in paragraphs 1.3-1.4,

1.13-1.16, 1.18, 1.20-1.23, but in fact still subsuming the stewardship objective under

decision-usefulness (as done in Par. 1.22 and BC1.10) is potentially misleading. Many

people will not have read BC1.10 where it is made clear that the IASB has rejected

the idea of identifying stewardship as a separate and equal objective of general

purpose financial reporting. I suspect that some people who asked for the inclusion of

stewardship as an objective may have in mind a different definition of stewardship,

and hence will not agree with the IASB’s interpretation of what information is needed

for achieving the stewardship objective of financial reporting. Some of the

respondents may have in mind a custodial/fiduciary type of stewardship. This requires

information roughly corresponding to proprietary theory’s perspective on the

objective of financial accounting and reporting. Others may have in mind a strategic

type of stewardship. This requires information roughly corresponding to decision-

usefulness theory’s perspective on the objective of financial accounting and reporting.

It also accords with view of the Trueblood Report and seems closest to the FASB’s

and IASB’s view on stewardship. Others may regard stewardship obligations to

include balancing the interests of all stakeholders. This will lead to an objective of

financial accounting and reporting in accordance with entity theory. Yet others may

have in mind a more corporate responsibility type of stewardship. This requires a set

of information that also satisfies enterprise theory’s perspective on the objective of

financial accounting and reporting. See for discussions of different forms of

stewardship Ijiri (1975), Birnberg (1980), and O’ Connell (2007). See for discussions

of the objective of general purpose financial reporting according to the different

equity theories Van Mourik (2010) and Van Mourik (2014).

If mentioning stewardship does not make any difference to the definition, recognition,

measurement, presentation and disclosure of the elements of financial statements, it

probably should not be mentioned as an objective at all. Par. 1.22 and BC1.10

subsume the stewardship function of financial reporting under its decision-usefulness

function. In the 2015 IASB CF ED, the stewardship function of financial reporting is

subsumed under the decision-usefulness function of financial reporting because the

IASB assumes that the information requirements are the same. This is because the

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IASB frames the use of financial reporting information for stewardship in terms of

assessing the entity’s earning power just as it does in the case of decision-usefulness.

This is debatable.

In the literature, among the sources indicating that the requirements are different,

Gjesdal (1980, 1981) argues that decision-usefulness (i.e. valuation) purposes and

stewardship (performance measurement, monitoring and contracting purposes) require

different types of information. Wagenhofer (2009: 76) argues that information that

serves decision-usefulness purposes destroys firm value if it is used for performance

measurement. Kȕhner and Pelger (2015) identify conditions where there is no perfect

mapping from stewardship to valuation and argue that accounting discretion affects

stewardship more significantly than valuation. Ijiri (1971, 1975) emphasised that to

fulfil the stewardship function of financial reporting, the information in the reports

has to be as hard and indisputable as possible. Demski and Sappington (1993) and

Demski (1994) argue that the verifiabililty of accounting information is what

enhances its usefulness for stewardship purposes. Barclay, Gode and Kothari (2005)

suggest that it is realised performance that is most useful for incentive contracts.

Whittington (2008) argues that in relatively imperfect and incomplete markets

financial reporting must enable current shareholders to perform their monitoring role

rather than meet the needs for the resource allocation decisions of passive investors or

speculators.

There are two other problems with the claim in Par. 1.22. First, on top of the fact that

there are multiple interpretations of what stewardship means, there is no real

agreement on what information best fulfils the different stewardship objectives.

Actually, even for the decision-usefulness objective, there is disagreement on the

information that best fulfils this objective. See the discussion of the different views on

how accounting information fulfils the decision-usefulness objective in the IASB and

the ASBJ by Van Mourik & Katsuo (2015).

The second problem with the claim in Par. 1.22 is that the IASB apparently does not

believe that there is a real difference in the stewardship functions of financial

reporting across the 116 countries where IFRS has been adopted. Watts (1977)

suggested that the decision-usefulness function of financial reporting requires a highly

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regulated environment. This point is important for the IASB because of the strong

influence from the FASB on the ideas about what should be the objective of general

purpose financial reporting and how to best achieve it as set out in the IASB

Conceptual Framework. All the thinking behind the FASB Conceptual Framework

(and much of the thinking behind the IASB Conceptual Framework) was based on the

institutional characteristics of the US financial and capital markets which are highly

developed, but also highly regulated and in which enforcement is strong. The IASB’s

view on stewardship fits uncomfortably with the international variety of institutional

environments in which IFRS has been adopted. The first problem is that there is great

divergence in the levels of enforcement. The second problem is that the IASB

assumes a set of complementary institutions similar to those in countries with well-

developed capital markets. This leads to the question: Is IFRS primarily intended for

multinational corporations and global investors? If so, in which ways does this serve

or damage the general international public interest?

I would support introducing financial reporting for stewardship purposes as a separate

and equal objective in the Conceptual Framework. It would then need to be reflected

in the definition, recognition, measurement, presentation and disclosure of the

elements of the financial statements in the ways outlined in my comments to the other

questions.

b)

The notion of prudence in financial reporting as defined in Par. 2.18 is an

interpretation from a decision-usefulness of information perspective. The decision-

usefulness perspective assumes risk-neutrality on the part of the (rational) investors,

and accordingly managers are also expected to be risk neutral. Prudence from a

stewardship perspective is about ensuring the reporting entity’s existence as a healthy

going concern. This requires a clear understanding of the extent to which financial

performance and financial position are based on ‘hard’ numbers and the extent to

which they are based on more uncertain numbers. Therefore, in financial reporting

prudence is probably more about verifiability (auditability), creditor protection, and

capital maintenance than about neutrality. Neutrality from a decision-usefulness

perspective is about avoiding bias in the representation of phenomena, as in Par. 2.17.

From a stewardship perspective, neutrality and objectivity in recognition,

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measurement, presentation and disclosure are about not systematically advantaging or

disadvantaging the (economic) interests of a particular stakeholder group in the

accounting for the business entity.

c)

In SFAC No. 2 of the FASB Framework (p. 6), representational faithfulness was

connected to the reliability of a measurement. In the IASB’s current proposal,

representational faithfulness falsely implies that we can always know the intended

economic substance of a phenomenon. Some transactions are constructed so as to

allow management flexibility in their decisions and actions. A faithful representation

must make it clear what the difference is between the legal form of a phenomenon and

the intended economic substance of this phenomenon for the reporting entity and its

potential economic consequences for different stakeholders.

d)

Measurement uncertainty derives from incomplete knowledge about the asset, liability,

income or expense item to be measured, and from the tool or procedure used to

measure the item. Uncertainty can make a measurement less reliable and therefore

less relevant if one does not dare depend upon it for making a decision. Precisely for

this reason, the definition, recognition, presentation and disclosure of the elements of

financial statements should probably indicate to what extent the measurement of an

element can be depended upon (is reliably quantified and likely to be realised) as a

basis for making decisions.

I think that without an explicit description of and commitment to an accounting model,

relevance and faithful representation do not provide a usable conceptual foundation

for defining the elements of financial statements and choosing criteria for their

recognition, their measurement bases and an approach to their presentation and

disclosure. Relevance defined as capable of making a difference in the decisions made

by users because it has predictive value, confirmatory value or both, implies that you

know how the information will be used and what it is being used for. Faithful

representation defined as complete, neutral and free from error implies that you (can)

know what the relevant underlying economic facts are, and that they are the same for

stewardship, investment decisions and general accountability purposes. What is

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relevant for monitoring, contracting and accountability purposes is not necessarily

equally relevant for valuation or investment purposes, and vice versa.

Question 2—Description and boundary of a reporting entity

Do you agree with:

(a) the proposed description of a reporting entity in paragraphs 3.11–3.12; and

(b) the discussion of the boundary of a reporting entity in paragraphs 3.13–3.25?

Why or why not?

(a) Yes.

(b) I don’t know.

Question 3—Definitions of elements

Do you agree with the proposed definitions of elements (excluding issues relating to

the distinction between liabilities and equity):

(a) an asset, and the related definition of an economic resource;

(b) a liability;

(c) equity;

(d) income; and

(e) expenses?

Why or why not? If you disagree with the proposed definitions, what alternative

definitions do you suggest and why?

General comment:

Identification of the elements of the financial statements to be defined needs to be

connected to the financial accounting model that underlies the definition, recognition,

measurement, presentation and disclosure in the financial statements. The IASB

thinks that the elements are assets, liabilities, equity, income and expenses. These are

the basic elements for which there are rules of double-entry bookkeeping. They are

not necessarily the only elements to be defined for financial reporting purposes. They

are, however, the only elements that need to be defined if:

you regard all-inclusive (comprehensive income) as the primary income

concept, and;

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you determine the all-inclusive income as the total of all the measured

(historical cost) and/or measurable (current values) changes in assets and

liabilities;

you take the total of all these measured and measurable changes to retained

earnings irrespective of whether or not the changes have been realised because

in your concept of income realisation does not matter;

you present and disclose all-inclusive income without distinguishing between

realised and unrealised revenues and expenses, and you present and disclose

all-inclusive income without distinguishing between realised and unrealised

gains and losses because the distinctions between realised and unrealised and

between revenues and gains, and expenses and losses do not matter.

On the other hand, if you don’t regard the all-inclusive concept of income as the

primary concept of income, it means that you give primacy to another concept of

income. You will need to provide definitions of more financial statement elements

because what an element is called, when and how it is recognised, in what way it is

presented and disclosed in the financial statements are not merely matters of

presentation. These definitions must include their bases for recognition and also

indicate principles for selecting the bases for their measurement.

If you regard profit or loss as the primary income concept and all-inclusive

(comprehensive income) as the secondary income concept, you would need to

define profit or loss and comprehensive income as well as the elements of

other comprehensive income (OCI). If you want the financial statements to

fully articulate, you would also need to define the elements of equity which

correspond with profit or loss as well as the elements of (accumulated) OCI.

Defining the profit or loss and the elements of OCI in the statement of

financial performance and accumulated OCI in the balance sheet requires

incorporating in these definitions the basis on which these elements will be

recognised (and possibly derecognised) in the financial statements.

Recognition of assets and liabilities is based on to what extent the property

rights owned (including the claims held) by the entity and the claims against

the entity’s property rights are measured or measurable, legally enforceable

and expected to be converted into revenues and expenses, and ultimately into

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cash inflows and outflows. Recognition of revenues, expenses, gains and

losses depends on to what extent they are realised or realisable.

For example, if profit or loss is the primary concept and you determine profit

or loss as the total of all the realised changes in assets and liabilities, you

would need to define OCI as the total of all the realisable changes in assets

and liabilities which will be recycled upon realisation.

You would also need to present and disclose assets and liabilities in

accordance with the type of property rights they represent and what their

likelihood of conversion into revenues, expenses, gains, losses and cash

inflows and outflows is. You would need to present and disclose profit or loss,

the elements of OCI and all-inclusive income, distinguishing between realised

and unrealised revenues and expenses, and realised and unrealised gains and

losses.

(a)

Definitions of assets used in the literature are:

Service potentials which are meant to produce future income (Paton &

Littleton),

Unexpired costs (management accounting)

Future cash flow potentials (Staubus),

Resources expected to produce future economic benefits (FASB, IASB),

Resources capable of producing future economic benefits (IASB),

Private property rights (Samuelson).

I do not agree that for general purpose financial reporting purposes an asset should be

defined as a resource. In business entities an asset is often used as a resource that

helps produce future benefits, but that does not make all the assets owned by the

entity economic resources. In business entities most assets are used as economic

resources, but some assets are private goods owned by the business for less well-

defined purposes. Not all assets have the same function, so maybe this needs to be

reflected in the definitions of the elements of financial statements. Currently, this

appears a matter of presentation, but it is possibly also a matter of definition. For

example, assets (and liabilities) that make up working capital may need to be defined

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slightly differently emphasising their roles in the business model of the entity. Capital

assets, non-current investments or intangibles may need to be defined separately as

subsets of assets.

The use of the word ‘rights’ rather than ‘property rights’ is unnecessarily vague.

Assets are separable and measurable property rights of the reporting entity in private

economic goods for which ownership is legally enforceable. The private property

rights that make up the ‘full’ or ‘liberal’ concept of ownership based on Honoré (1961,

pp. 107-147) according to Becker (1977, pp. 18-19) include: (1) the right to possess,

(2) the right to use, (3) the right to manage, (4) the right to the income, (5) the right to

the capital, (6) the right to security from expropriation, (7) the right to sell or bequeath

the thing, (8) the absence of term, (9) the prohibition of harmful use, (10) liability to

execution (as repayment for debt), and (11) residuary character.

Suggested definition:

Asset: As a financial statement element an asset is either cash, or another 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 by the

reporting entity,

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.

(b)

Suggested definition:

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. Liabilities can include claims resulting from obligations that are

entered into for prudential purposes (such as improving the entity’s reputation or

public image) or moral (i.e. ethical or social) purposes.

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Like in the case of assets, liabilities that are part of working capital may need to be

defined as such. Similarly, when entities use non-current liabilities strategically or for

speculative purposes rather than simply to finance their capital investments, they may

need to be defined, presented and disclosed differently as well.

(c)

Net assets: Total assets less total liabilities.

Surplus: Net assets less share capital. The elements of surplus depend on a choice for

clean surplus or dirty surplus and need to be clarified when choosing a primary

income concept and defining profit or loss and OCI.

Equity: Under the clean surplus view of equity, equity is equal to share capital and

surplus which is constituted of retained earnings only. Under the dirty surplus view,

equity is equal to share capital and surplus which is constituted of retained earnings

plus any elements that have bypassed profit or loss. These elements have to be

defined and disclosed separately.

(d) and (e)

If IAS 18 and IFRS 15 differentiate between income and revenues, the IASB

Conceptual Framework would need to do the same in its definitions.

Suggestions:

Income: Realised revenues, realised gains, realisable revenues, realisable gains.

Expenses: Realised expenses, realised losses, realisable expenses, realisable losses.

Realised revenues (expenses) are the increases (decreases) in profit or loss from the

reporting entity’s normal business activity corresponding to the increases (decreases)

in assets or the decreases (increases) in liabilities to which measurement uncertainty

and outcome uncertainty deriving from the characteristics of market prices in

incomplete and imperfect markets, and corresponding fluctuations in market prices,

exchange rates, discount rates, expected future cash flows etc. no longer apply

because they have been realised.

Realisable revenues (expenses) in profit or loss are the increases (decreases) in

profit or loss from the reporting entity’s normal business activity corresponding to the

increases (decreases) in assets or the decreases (increases) in liabilities to which

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measurement uncertainty and outcome uncertainty still apply and the chance of them

not materialising is at a prudent level (say, up to 10 percent). This may depend on the

level of prudence that the entity has committed to in advance.

Realised gains (losses) are the increases (decreases) in profit or loss from the sale of

capital assets or non-current investments corresponding to the increases in assets or

the decreases in liabilities to which measurement uncertainty and outcome uncertainty

no longer apply because they have been realised.

Realisable revenues (expenses) in OCI are the increases (decreases) in OCI from the

reporting entity’s normal business activity corresponding to the increases (decreases)

in assets or the decreases (increases) in liabilities to which measurement uncertainty

and outcome uncertainty still apply and the chance of them not materialising is at a

risky level (say, above 10 percent). These revenues and expenses must be recycled

upon realisation.

Realisable gains (losses) in OCI are the increases (decreases) in OCI from the

reporting entity’s abnormal business activities corresponding to the measurable and

realisable increases (decreases) in assets or the measurable and realisable decreases

(increases) in liabilities to which measurement uncertainty and outcome uncertainty

still apply. These gains and losses must be recycled upon realisation.

Question 4—Present obligation

Do you agree with the proposed description of a present obligation and the proposed

guidance to support that description? Why or why not?

I define a liability as a legally enforceable claim by another party for the entity to

fulfil an obligation. It is probably not exactly the obligation itself. However, Par. 4.31

probably does what it is intended to do.

Question 5—Other guidance on the elements

Do you have any comments on the proposed guidance?

Do you believe that additional guidance is needed? If so, please specify what that

guidance should include.

Since I do not agree with the ED’s approach to defining and recognising the elements

of financial statements, I can’t really comment on Question 5.

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Question 6—Recognition criteria

Do you agree with the proposed approach to recognition? Why or why not? If you do

not agree, what changes do you suggest and why?

I think that the definition, recognition, measurement and presentation of elements of

financial statements should be logically connected to an accounting model. In addition,

I think that prudence in accounting (defined as: a very low level of measurement

uncertainty and outcome uncertainty deriving from the characteristics of market prices

in incomplete and imperfect markets and corresponding fluctuations in market prices,

exchange rates, discount rates, expected future cash flows etc.) is important for the

definition, recognition, measurement, presentation and disclosure of assets and

liabilities in the statement of financial position and for revenues and expenses to be

included in profit or loss.

Par. 5.2 states that meeting the definition of an element is the criterion for recognition,

but then Par. 5.9 and onwards add the criteria of relevance, faithful representation,

and cost. These should also be included in Par. 5.2.

The diagram in Par. 5.5 is consistent with an all-inclusive concept of income and a

clean-surplus concept of equity. It is incomsistent with the determination and

disclosure of OCI and accumulated OCI and the primacy of the statement of profit or

loss.

Par. 5.7 states: ‘However, the purpose of the financial statements is not to show the

value of the entity and, therefore, not all assets and liabilities are recognised.’ The use

of the word ‘therefore’ is inappropriate here because the second part of the sentence is

not a logical consequence of the first part. In addition, one of the purposes of the

balance sheet is precisely to show the book value of the entity. It is up to the users of

financial statement information to determine the entity’s goodwill.

Par. 5.10 says that ‘judgement is required when deciding whether to recognise an item

and recognition requirements may need to vary between Standards.’ I think this is too

vague because it says nothing about the types of judgement that are necessary, how

these judgements are made and what their consequences are.

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Question 7—Derecognition

Do you agree with the proposed discussion of derecognition? Why or why not? If you

do not agree, what changes do you suggest and why?

I don’t know.

Question 8—Measurement bases

Has the IASB:

(a) correctly identified the measurement bases that should be described in the

Conceptual Framework? If not, which measurement bases would you include and

why?

(b) properly described the information provided by each of the measurement bases,

and their advantages and disadvantages? If not, how would you describe the

information provided by each measurement basis, and its advantages and

disadvantages?

In a broader interpretation of the stewardship role of financial reporting, measurement

would not be only discussed with reference to having predictive value (for investment

decisions made on the basis of expectations with respect to the future) and feedback

value (regarding information disclosed in the past enabling the evaluation of decisions

made in the past and adjusting them for the future). Measurement is not only relevant

to resource allocation decisions. If enabling managers to discharge their stewardship

obligations is a financial reporting objective in the Conceptual Framework, why does

the ED not discuss the measurement (and recognition) of assets, liabilities, income

and expenses with reference to its relevance for: contracting, the determination of

dividend payout ratios, rent extraction between majority and minority shareholders,

the determination of managerial remuneration and employees’ bonuses and salaries,

the use of leverage for the short-term benefit of senior management and the residual

shareholders, the consequences for the entity’s credit ratings, or the relation between

creditor/lender protection and the maintenance of a reporting entity’s productive

capital? These are the issues that create the conflicting interests of the entity’s

different stakeholders which its management must reconcile. Particularly in

jurisdictions where shareholder value maximisation is not the top priority,

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stewardship is not just about pleasing the shareholders by maximising their returns. It

is about making sure that the entity survives even if this means satisficing instead of

maximising returns to the shareholders so that the interests of other stakeholders can

also be served. It is also about being accountable for the entity’s performance and for

achieving this performance without systematically advantaging one set of

stakeholders over another.

(a) The IASB categorises measurement bases into the two categories of historical cost

and current values only. This categorisation links with the discussion on the

presentation of income and expenses in the statement of profit or loss and income and

expenses in OCI in paragraphs 7.19 to 7.27. If, as is the case with the IASB

Framework, you care about measurements having predictive value and feedback value

for the purpose of estimating future returns and future cash flows, but you don’t

particularly care how the revenue, expenses, gains and losses have been generated and

whether they have been realised or not, maybe this categorisation is sufficient.

In the case of fair value, the assumption that fair values reflect market participants’

expectations about the amount, timing and uncertainty of the cash flows that are

priced in a manner that reflects their risk preferences (2015 CF ED: Par. 6.28) holds

only in circumstances where the market price is observable in an active market under

perfect competition. Therefore, I think that Par. 6.23 must make clear that the factors

reflected by fair value in active markets become very noisy in other types of markets

or very subjective when there are no markets. Par. 6.32 does not discuss in sufficient

detail the informational impact of the characteristics of the markets in which the

prices are observed, substituted or simulated on the risk of non-realisation, the level of

measurement uncertainty and outcome uncertainty.

The own credit risk issue in Par. 6.24 and 6.25 (and Par. 6.36) is a good example of

the IASB’s focus on decision-usefulness rather than stewardship because it does not

care how returns are generated and it ignores the perverse incentives that the own

credit risk ‘premium’ provides. An entity’s liabilities are not simply negative assets.

Liabilities represent enforceable claims from an entity’s stakeholders.

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Par. 6.25: Should ‘as the entity is subsequently released from risk’ read ‘as the

entity’s credit rating subsequently deteriorates’?

Question 9—Factors to consider when selecting a measurement basis

Has the IASB correctly identified the factors to consider when selecting a

measurement basis? If not, what factors would you consider and why?

First, I will respond to Steve Cooper’s five questions in ‘Taking a measured approach’

of September 2015, and then I will answer question 9.

(1) Should a single measurement method be applied to all recognised assets and

liabilities?

The 2013 DP the IASB explained the problems associated with measurement of all

assets and liabilities at either historical cost or fair value, and motivated a choice for a

mixed measurement approach. I agree that a single measurement basis is not feasible.

Even if a single measurement basis were feasible, it would not solve the aggregation

problem.

(2) In selecting a measurement method, should one consider the impact on, and

relevance for understanding, financial position, financial performance or both?

It is important to consider the impact of recognising and measuring an item on the

determination of both (realised or as good as realised) profit or loss and retained

earnings because this will provide predictive and feedback value for both stewardship

and decision-usefulness purposes. The impact on OCI and accumulated OCI is more

likely to provide some predictive value to users for decision-usefulness purposes, but

much less for stewardship purposes related to monitoring and the reconciliation of

conflicting interests.

(3) How should the ease or difficulty of establishing a given measure affect the choice

of a measurement method?

Using measurements that are verifiable, auditable, transparent and replicable is easier

and potentially keeps subjectivity to a level where it is still understandable. I believe

that measurement uncertainty and outcome uncertainty must be very low for changes

in assets and liabilities to be included in profit or loss and retained earnings. They

should be realised or as good as realised (if they result from measured and recognised

changes in working capital items). In this case, if volatility results from measured and

realised changes in assets and liabilities, this is simply a fact of business reality. Some

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industries experience more cyclicality and volatility than others, and financial analysts

and other users will be aware of this. Items to be included in OCI and accumulated

OCI can be subject to a somewhat higher level of measurement uncertainty and

outcome uncertainty as long as they are recycled upon realisation. If volatility of

profit or loss is introduced by recognising in profit or loss measurable (but unrealised)

changes in assets and liabilities that are not part of the working capital of the business,

this type of volatility probably reduces both the predictive and feedback value of

profit or loss.

(4) How should business activities affect the choice of a measurement method?

An entity’s business model probably should affect how assets and liabilities, revenues,

gains, expense and losses are recorded and measured. When items are part of the

entity’s working capital, changes in these items probably should be recognised and

measured in a different way than when they are not part of the entity’s working

capital. For entities which engage in business activities of a speculative nature,

volatility of market prices is part of the reason for their being and the fair values of

the working capital items will be more relevant than for manufacturing, service or

trading businesses.

(5) Could measurement for performance differ from that used for financial position?

This is incompatible with an accounting model based on the all-inclusive

(comprehensive) income and the clean surplus concept of equity. It is compatible with

an accounting model that gives primacy to profit or loss over comprehensive income.

If items are measured at current values in the statement of financial position and the

corresponding realised changes in those items are reflected in profit or loss whereas

the realisable changes are reflected in OCI, the items in OCI will have to be recycled

upon realisation in order to preserve the correspondence of cumulative profit or loss

with cumulative retained earnings and cumulative net cash inflows over the life of the

entity.

In answer to question 9, I find the discussion of factors to consider when selecting a

measurement basis without the adoption of an accounting model difficult to

understand. Par. 6.54 (a) and (b) start an explanation of the importance of considering

how an asset or liability contributes to future cash flows. However, it does not explain

what we are trying to measure when measuring the different elements of financial

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statements (this would need to be closely linked to the definition and recognition of

the elements) or what this means for selecting a measurement basis.

The logic for selecting a measurement basis must be rooted in what a measurement

offers in terms of its relevance to the decision at hand and its reliability because you

need to know to what extent you are able to depend on it. I believe that this must be

reflected in the recognition and presentation of the element or item as well. The IASB

CF ED presents the decision-usefulness perspective (where stewardship is subsumed

under decision-usefulness) as being all about deciding on whether to hold, buy or sell

the entity’s equity and debt securities. In this case, predictive value might be more

important than feedback value, so measurement can, perhaps, be subject to a slightly

higher degree of measurement uncertainty and recognition can, perhaps, be subject to

a slightly higher degree of outcome uncertainty. The thinking behind the 2006 ASBJ

Conceptual Framework Discussion Paper is based on the idea that, even for these

types of decisions, feedback value is at least equally important to predictive value.

This is why the ASBJ thinks that realisation (or at least release-from-risk) of revenues,

gains expenses and losses is important for the recognition and measurement of

elements recognised in profit or loss. I don’t know which is true, but intuitively, I

agree with the ASBJ. What I do know is that this is a discussion that would need to

take place when establishing the IASB Conceptual Framework and its underlying

accounting model, vision of ideal financial reporting or what you would like to call it.

In addition, if stewardship is about holding management to account for the entity’s

financial performance, financial position, risk management strategy and its impact on

other stakeholders, and to decide on their continuation or discharge, or how to reward

them, knowing the ‘hardness’ of the measures attached to assets and liabilities (lower

uncertainty about their existence and potential future benefits or losses, and lower

measurement uncertainty) and the realisation or release-from-risk of revenues, gains,

expenses and losses (lower outcome uncertainty) makes it easier to hold management

to account for their past performance.

If having decision-usefulness and stewardship as objectives leads to a requirement of

having two concepts of income and dual measurement between balance sheet and

income statement, that is fine. But, in that case, profit or loss has to be the primary

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income concept, and its elements have to be clearly defined, and unambiguously

recognised and measured (and recycled), because otherwise, comprehensive income

will be the primary income concept by default.

Question 10—More than one relevant measurement basis

Do you agree with the approach discussed in paragraphs 6.74–6.77 and BC6.68?

Why or why not?

Par. 6.74 or 6.76 should explain why dual measurement is sometimes necessary in a

better way than simply to say that this provides more relevant information. BC6.68,

BC7.49 and BC7.50 do not explain this either.

It is therefore difficult to comment in a way that contributes anything because I can

only guess what this is about. If this comes from the ASBJ, it needs to be viewed from

the perspective of an accounting model that regards profit or loss as the primary

income concept and comprehensive income (all-inclusive income) as the secondary

income concept. The 2006 ASBJ Conceptual Framework Discussion Paper defines,

recognises and measures the elements of profit or loss as realised or released-from-

risk. Hence, unrealised changes in the measurements of assets and liabilities are

parked in OCI until they are realised upon which they are recycled to profit or loss.

I fully agree with the 2006 ASBJ Conceptual Framework DP in this respect, but I am

a little hesitant about the IASB ED’s way of phrasing and introducing it because it

does not seem to be attached to a coherent and explicit accounting model in the way

that it is in the 2006 ASBJ Conceptual Framework DP. By the way, I do believe that

there is much room for improvement in the 2006 ASBJ Conceptual Framework DP,

but at least it has a theoretical accounting model as its basis.

Question 11—Objective and scope of financial statements and

communication

Do you have any comments on the discussion of the objective and scope of financial

statements, and on the use of presentation and disclosure as communication tools?

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I would have expected an explanation of the information in each of the financial

statements and specifically how this information is meant to help users to assess the

prospects for future net cash inflows to the entity and in assessing management’s

stewardship of the entity’s resources either in Par. 7.2 to 7.7 of Chapter 7 or in Par.

3.2 to 3.8 of Chapter 3. For example, why does the IASB deem the particular way of

presenting non-current assets and liabilities, current assets and liabilities and equity in

the statement of financial position more useful than any other way? The same could

be asked for the statement of changes in equity, and the statement of financial

performance. If the IASB does have a vision of ideal financial reporting and there is

some kind of underlying logic, this would be a good place as any to explain it.

In my answer to question 3 I suggested definitions which would lead to presenting in

profit or loss only those revenues, gains, expenses and losses that have been realised,

plus those realisable revenues and expenses that are generated and incurred in the

process of an entity’s normal business activities AND whose measurement and

outcome uncertainty are below a certain level specified in advance (either by the

reporting entity by committing to a level of prudence, or as a general principle in the

IASB Conceptual Framework, or at industry or standards level). Other realisable

revenues and expenses or gains and losses would go into OCI and would need to be

recycled upon realisation. Such a presentation would also affect the presentation of

equity in the balance sheet, and could be consistently applied to assets and liabilities

as well. Assets and liabilities could be presented based on prudence with respect to

working capital items (which would be below a certain specified level of uncertainty

about their existence and potential future benefits or losses, and lower measurement

uncertainty), capital assets and liabilities used to finance them, as well as speculative

assets and liabilities, so that it would be clearer what levels of uncertainty and risk are

attached to which assets and liabilities.

Question 12—Description of the statement of profit or loss

Do you support the proposed description of the statement of profit or loss? Why or

why not?

If you think that the Conceptual Framework should provide a definition of profit or

loss, please explain why it is necessary and provide your suggestion for that definition.

21

Par. 7.20 (b) would need to explain in more detail how the elements recognised and

disclosed in profit or loss help assess the prospects for future cash flows and how it

helps assess management’s stewardship of the entity’s resources.

Par. 7.21 commits a logical fallacy by using the word ‘Hence’ because Par. 7.21 does

not deductively follow from Par. 7.20.

Par. 7.23 commits a similar logical fallacy because the presumption that profit or loss

must be all-inclusive does not deductively follow from the idea that the statement of

profit or loss is the primary source of information about an entity’s financial

performance. The most that can be said is that the statement of profit or loss contains

information that possesses certain qualities or characteristics that make it the primary

source of information about an entity’s financial performance. All-inclusiveness is

unlikely to be such a characteristic if there is a role for OCI.

Furthermore, why can the presumption not be rebutted for income and expenses

related to assets and liabilities measured at historical cost? I think that this can only be

because they have been realised, but apparently the IASB does not want to say that.

Par. 7.24 says that the presumption can be rebutted for income and expenses relate to

assets and liabilities measured at current values, if excluding them from profit or loss

enhances the relevance of the information in the statement of profit or loss for the

period. BC7.43 and BC7.44 means that judging what enhances relevance and why is

something that only the IASB can do when setting standards. In other words, only the

IASB can decide when the measurement and outcome uncertainty is so high that it

renders items recognised and measured at current values too unreliable to depend on

for decision making. What the criteria are that the IASB will use is not discussed. A

definition of profit or loss is necessary for the reasons I set out in my response to

question 3.

Question 13—Reporting items of income or expenses in other

comprehensive income

Do 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?

22

If you disagree, what alternative do you suggest and why?

See my responses to questions 8, 9, 10, 11 and 12.

Question 14—Recycling

Do 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?

Maybe, but it must be clear what is the conceptual thinking behind the rebuttable

presumption. The IASB Conceptual Framework must explain much more concretely

the conceptual basis on which the presumption cannot be rebutted for assets and

liabilities measured at historical cost, and the conceptual basis on which it can be

rebutted for items measured at current values. Currently, the IASB says: Leave it to us

to decide.

Par. 7.23 and Par. 7.24 are very difficult to understand because it is not clear what

they are talking about. BC7.47 is not very helpful in understanding the principled

basis. It could be that the IASB is trying to introduce the realisation concept (or

something inspired by the ASBJ’s released-from-risk concept) here without wanting

to name it. Unfortunately, without specifying the principled basis on which the IASB

can decide that excluding income or expense items from profit or loss makes it more

relevant, it is not possible to know what I would be agreeing to or not. Particularly

since the IASB gives conflicting signals in BC7.42 to BC7.47 by not establishing a

principled approach. BC7.48 represents a first step but is not enough.

Question 15—Effects of the proposed changes to the Conceptual

Framework

Do 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?

I don’t know.

23

Question 16—Business activities

Do you agree with the proposed approach to business activities? Why or why not?

I can find very little in the IASB CF ED that proposes a clear approach to giving

consideration to the entity’s business activities when defining, recognising, measuring,

presenting and disclosing the elements of financial statements. BCIN.28 to BCIN.34

discuss the reporting entity’s business model in respect of comments received on the

2013 DP because a long-term perspective on investment is considered a desirable goal

by governments and others.

BCIN.37 says that the only way the IASB CF ED has incorporated the idea of

incorporating the business model and long-term investment as a business activity is in

the selection of a measurement basis, where it considers how the asset or liability

contributes to the entity’s future cash flows. BC6.45 to BC6.49 says that in the ED

much of the discussion on the contribution to future cash flows has been removed.

BC6.52 says that the ED states how an asset or liability contributes to the entity’s

future cash flows will depend, in part, on the nature of the business activities being

conducted. Unfortunately, it is not clear to me precisely how the ED proposes that this

will affect the selection of a measurement basis.

Question 17—Long-term investment

Do you agree with the IASB’s conclusions on long-term investment? Why or why not?

The IASB does not think that long-term investors in equity or debt securities have

different information needs than short-term or medium-term investors in equity or

debt securities (BCIN.40). This is only more or less true if you adopt, as the IASB has

done, a narrow interpretation of stewardship. I believe that stewardship is about much

more than determining distributions of dividends and bonuses. Long-term investors

are more likely to perform their monitoring role in the entity’s corporate governance

than short-term investors. For this they need as much information as possible that is

subject to as little measurement and outcome uncertainty as possible. If long-term

investors care as much about the long-term stability of the returns generated as about

the size of the returns, and as much about the usefulness for determining the integrity

and moral character of the entity’s management as about the usefulness of information

24

for predicting future cash flows they need as much information as possible that is

subject to as little measurement and outcome uncertainty as possible.

The IASB believes that it is not the role of accounting standards to encourage or

discourage investments that have particular characteristics (BCIN.44 (b). Although it

may not be the role of accounting standards in a market economy, it is the case that

accounting standards do have an impact on managerial behaviour, intended or not.

Furthermore, the IASB believes that it is making an important contribution to long-

term investment by producing IFRS that require transparent financial reporting. The

IASB is making a contribution to global investment, which is not necessarily long-

term investment.

Question 18—Other comments

Do 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.

(I) The objective of general purpose financial reporting and how best to achieve

it in Chapter 1 has not been through a proper due process

The IASB claims that the objective of general purpose financial reporting in Chapter

1 was ‘completed only recently’ and has been ‘through extensive due process’ (2015

BfC ED: BC 1.2). However, I believe that the question of the objective of general

purpose financial reporting and the fundamental ideas behind how best to achieve this

objective (i.e., the logic underpinning the IASB Conceptual Framework) has never

been through a due process commensurate with the IASB’s current mandate,

objectives and the environment it operates in.

1. The chapters on the objective of general purpose financial reporting and the

qualitative characteristics of useful information were the result of a

convergence project between the FASB and the IASB. This project aimed to

iron out any differences between the FASB and IASB Conceptual Frameworks.

The objective of general purpose financial reporting in the IASB 2010

25

Conceptual Framework has not been fundamentally revisited since the

establishment of the 1989 IASC Framework.

2. In 1989, the IASC did not have the same mandate and impact as does the

IASB today. The 1989 IASC Framework was established using the

comparatively rudimentary IASC due process that had not changed much

since its establishment in 1973, which was probably adequate for the IASC in

1989. For the IASB and IFRS Foundation today, not only the due process

itself would be different and more extensive, also the constituents have grown

in size and diversity of interests.

3. In 1989, the IASC had followed the building block approach which meant that

the objective of general purpose financial reporting was not systematically

considered in conjunction with the question how best to achieve this objective.

Neither the 2010 revision as part of the convergence project with the FASB

nor the 2013 Discussion Paper was about a fundamental review of the

objective of general purpose financial reporting and how best to achieve it.

4. The 1989 IASC Conceptual Framework followed the FASB Framework’s

approach and structure, which was developed with the institutional

environment and the public interest of the USA in mind (See SFAC No. 1, Par.

9 to 13). It did not consider the variation of institutional environments of the

countries where IFRS has been adopted so far.

I believe that a review of Chapter 1 is necessary to enable the IASB Framework to

perform its function of giving the IASB intellectual credibility and legitimacy. As a

private standard setter, the IASB needs a conceptual framework to give its IFRS

intellectual legitimacy and credibility in order to be able to defend its decisions

against political arguments from special interest groups among its constituents. In

Intellectual credibility and legitimacy derive from coherence. An underlying

accounting model would form the basis for such coherence because it links with how

this model is meant to produce information that best achieves the objective of general

purpose financial reporting.

(II) The IASB Conceptual Framework should adopt an underlying theoretical

accounting model that provides the logic for the definition, recognition,

measurement, presentation and disclosure in a coherent way.

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Although the 2015 CF ED does say that the IASB has a vision of ideal financial

reporting (2015 CF ED: Par. 1.11), the 2015 CF ED does not explain and summarise

what this ideal is, or where this ideal comes from and why it is considered ideal. The

2015 BfC ED does not explain this paragraph at all. What is this vision of ideal

financial reporting? Is this an accounting model? Is it only implicit?

(III) Inconsistencies and intellectual compromises under political pressure, as

spin, or out of a disregard for accounting theory?

There are a several inconsistencies in the 2015 CF ED. These inconsistencies may be

caused by intellectual compromises which the IASB has had to make in order to

accommodate political pressure from different constituents. These inconsistencies

may also be caused by the IASB having an underlying vision of ideal financial

reporting which the IASB thinks it cannot be explicit about because certain important

constituents will not support it. Some inconsistencies give me the impression that the

IASB is saying one thing (because some key constituents demanded it in their

comments) but in reality is doing another (because other slightly more important key

constituents demand it, or perhaps because this is what the IASB truly believes in).

Apparent inconsistencies make it difficult to accept the intellectual credibility of IFRS

and intellectual authority of the IASB’s Conceptual Framework.

1. For example, the constituents’ comments on the DP urged the IASB to include

stewardship as an objective (2015 BfC ED: BC1.8). So, in the 2015 CF ED the

word ‘stewardship’ is mentioned. Nevertheless, as mentioned in my response

to Question 1, the substance of the objective of general purpose financial

reporting in the 2015 CF ED has not changed at all. Subsuming stewardship

under decision-usefulness as an objective is potentially misleading because

many people will expect this to make a difference to the financial accounting

and reporting.

2. A second example is the IASB’s preference for the determination and

disclosure of income on an all-inclusive basis. This means that, by default,

comprehensive income is the primary financial performance concept (2015

BfC ED: BC7.42), which is inconsistent with the determination and

disclosure of equity on a dirty surplus basis (having accumulated OCI in

equity) and making the statement of profit or loss the primary statement of

financial performance. It is also inconsistent with the comments from those

27

constituents who think that profit or loss is more useful on its own (as a

starting point for analysis) than is comprehensive income on its own (as a

starting point for analysis). The Exposure Draft assumes that because users

consider the statement of profit or loss to be the primary source of information

about an entity’s financial performance for the period, all income and

expenses will need to be included in the statement of profit or loss (2015 CF

ED: Par. 7.23). This ignores the common sense idea that many people support

the primacy of profit or loss precisely because it excludes items that introduce

measurement uncertainty and outcome uncertainty deriving from the

characteristics of market prices in incomplete and imperfect markets, and

corresponding fluctuations in market prices, exchange rates, discount rates,

expected future cash flows etc. into the determination of a reporting entity’s

income.

3. A third example is that the IASB in its Exposure Draft frames the usefulness

of financial reporting information in terms of relevance and faithful

representation without committing to an accounting model that would result in

definitions of profit or loss (2015 BfC ED: BC7.34 and BC7.41) and equity.

The IASB takes this pragmatic stance in spite of the fact that the IASB thinks

that all the other aspects of the Conceptual Framework flow from the objective

of financial reporting (2015 CF ED: Par. 1.1) and that the IFRS Foundation’s

Constitution commits the IASB to developing IFRS based on clearly

articulated principles (IFRS Foundation, 2013: Par. 2(a)). In reality, in

Chapters 4 to 7 of the ED the IASB is saying: ‘Leave it to us to decide at

standards level what decision-usefulness, relevance and faithful representation

mean for choosing a recognition and measurement basis, and a basis for

presenting and disclosing the elements of the financial statements.’

Has the IASB has abandoned the search for coherence and intellectual credibility of

the recognition, measurement, presentation and disclosure aspects of the Conceptual

Framework? Is this because the IASB is trying to appease certain key constituents

with conflicting opinions or interests? I believe that the IASB should establish a

Conceptual Framework that is internally consistent and theoretically sound, rather

than compromise in the Conceptual Framework in order to accommodate standards.

When the need arises to compromise at standards level, it is better to be honest about

28

that and make accountability for and transparency about intellectual compromises

under political pressure part of the due process for standard setting.

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