The concepts are changing
It is important that for financial reporting information to be useful, the guidance under which financial reports are prepared should be founded on sound and consistent general principles.
We continue to wait on the completion of standards by the IASB in a number of key areas - revenue recognition, financial instruments, leasing and insurance – which have been in progress for a number of years, but in some cases still without any clear light at the end of the tunnel. While much is written about difficulties in reaching conclusions in such areas as impairment and insurance, it is also of concern that other topics including revenue recognition and hedging are still not finalised even though the green light has appeared to be coming on for some time. January 2015 was the target date for implementation when much of this work commenced at the peak of the financial crisis, but for some time has been dispensed with as unattainable. As time goes by, one wonders if 2016 or 2017 will also become not achievable.
A joint approach - No more!
The quest for convergence of standards and in particular the joint projects of the International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB) on those key areas noted above has, it seems, not made it any easier to achieve joined-up thinking. Perhaps it is difficult for either to find the path to righteousness, or even a middle ground, when one is coming from a principle based approach while the other has over time favoured a cookery-book approach. Can disparate thought processes come together when their starting points are so different, or are there even more fundamental underlying issues that render convergence almost impossible to achieve? Nonetheless, they have achieved success in some major areas with fair value and the consolidation standards being notable high points, with the new standard on revenue recognition likely to be published by the end of 2013.
The decision by the IASB earlier this year to discontinue the approach of joint-standard setting with the FASB is a welcome one. The aforementioned projects will be completed jointly, otherwise the IASB will move forward with the development and revision of standards without any constraints imposed by having to reach consensus with the FASB. With the exception of the USA, worldwide usage of IFRS has almost been achieved, and should now be able to move forward in a more efficient and effective manner. Given the various checks and balances within the standard - setting process, and the input and influence of constituents, there should be no diminution in quality and relevance of standards.
The European dimension
In a European context, the work carried out by the European Financial Reporting Advisory Group (EFRAG) is of major importance to the process of endorsement of standards for use in Europe, and it has a powerful voice with the IASB. The adoption of IFRS in Europe has greatly assisted in giving IFRS the credibility and critical mass needed to become the single set of globally accepted accounting standards. It is clear that the adoption of IFRS has improved the transparency and consistency of financial reporting in the EU, albeit that recent comments from European Supervisory Authorities indicate that there remains considerable scope for improvement in the consistent application of standards.
It is encouraging that one of the first projects to be undertaken since the break up is a comprehensive Discussion Paper (DP) for a new Conceptual Framework, which has been published in recent months. In doing so, the IASB is setting out proposals and seeking views on topical areas where it considers revision of the existing conceptual framework is necessary.
The DP contains about 240 pages and is divided into 9 sections, which are accompanied by eight appendices. Some of the more significant features of the proposals are:
- Assets and liabilities – the framework will no longer refer to expected inflows or outflows of economic benefits, but instead directly to the underlying resource or obligation. An economic resource is defined as a right or other source of value that is capable of producing economic benefit. Additionally, the notion of probability will be removed from the definition requirements.
- De-recognition - for the first time, the framework will contain de-recognition requirements.
- Equity – the proposed introduction of a requirement to update the measure of the different classes of equity claims at the end of each reporting period in order to show dilution effects. The question is also addressed of whether the most subordinated class of financial instruments should be treated as equity of an entity that has issued no equity instruments.
- Comprehensive income – all income and expenses will be shown in profit and loss unless relating to the re-measurement of assets and liabilities which would normally be shown in other comprehensive income with recycling generally permitted. A definition of profit and loss is not included.
- Presentation and disclosure – this new section contains a longer explanation of the purpose of the primary financial statements and the notes to the financial statements and their relationship. There has been a major call for the improvement of financial reporting disclosures and the need for developing more concise, understandable and helpful information. A fundamental element of this is to deliver an understanding of how an entity conducts its business activities, its business model.
EFRAG – draft response
EFRAG has already published a draft comment letter in response to the DP. While largely positive in its comments, EFRAG does question whether some of the issues should be addressed on a more conceptual basis, with the concern that many of the principles proposed have been generated from requirements in current standards without their justification being debated conceptually. EFRAG considers that the revised conceptual framework should be based on an understanding of how clear objectives of financial reporting should be met in practice.
Since April 2013, EFRAG and the National Standard Setters of France, Germany, Italy and the UK have published bulletins which discuss issues expected to arise in the course of the IASB’s Conceptual Framework project. Seven of these have been published to date, including those on prudence, reliability, uncertainty, the business model, the role of a conceptual framework, the asset/liability approach and accountability.
The most recent of these on accountability discusses whether financial statements should provide information that is useful for an assessment of management’s accountability (or stewardship) and whether this objective is adequately reflected in the IASB’s conceptual framework. There has been a certain lack of clarity in the approach being taken by the IASB to ‘stewardship’ in the context of financial reporting. Stewardship, which is all about directors’ duties, must focus on the management of resources with the longer-term viability of business being dependent on the sustainability of resources and the ability of current stewards to manage them in an efficient manner and not be wasteful. EFRAG believes that the provision of information on accountability/stewardship is a primary objective of financial reporting and should be clearly dealt with in the conceptual framework.
The IASB’s DP explains that the primary purpose of the conceptual framework is to assist the IASB in developing and revising IFRS standards and that the framework does not override any specific standards. It is important that for financial reporting information to be useful, the guidance under which financial reports are prepared should be founded on sound and consistent general principles.
While the amendment of the Conceptual Framework will not have any immediate consequences for how financial statements are prepared, it will play a major role in the development and amendment of standards into the future.