Financial Reporting Brief

September 2015

Our featured article for September is 'Conceptual Framework – A New Foundation', with Brendan Sheridan commenting on the Exposure Draft recently issued by the IASB with proposals on the revision and amendment of the Framework which is fundamental to developing standards that bring transparency, accountability and efficiency to financial markets around the world.

Conceptual Framework- A New Foundation

In recent months, the International Accounting Standards Board (IASB) has published a comprehensive Exposure Draft (ED) containing proposals for revision and amendment of the existing Conceptual Framework, primarily in topical areas as considered necessary. This project has taken quite some time to yield any results with the extant Framework unchanged since its inception in 1989, despite efforts to move it along particularly in 2004 and 2010. The closing date for comment on the ED is 26 October 2015. The IASB aims to finalise the revised Conceptual Framework in 2016.

The main ED is accompanied by an ED containing proposals regarding references to the Conceptual Framework in other IASB pronouncements, including standards and interpretations. The IASB is considering granting a transition period of approximately 18 months for the amendments proposed in this ED in order to give preparers time to identify, understand and adjust to possible implications.

The IASB sees that some improvements are needed and these are being proposed to:-

  • Fill gaps - for example, to provide additional guidance on presentation and disclosure of financial information
  • Update - to address some areas that are out of date, including the existing guidance on when assets and liabilities should be recognised
  • Clarify - to improve the clarity of the role measurement uncertainty plays in deciding how to measure assets, liabilities, income or expenses.

The main objective for the revision of the Conceptual Framework is to bring clarity to the underlying accounting model on which IFRS are developed and hence minimise fundamental discussions at standards level. It is fundamental that the Conceptual Framework continues to help the IASB to successfully pursue its stated mission to develop standards that bring transparency, accountability and efficiency to financial markets around the world.

The Exposure Draft

The ED published by the IASB is comprehensive and contains proposals for areas in which it considers a revision of the Conceptual Framework is necessary. The proposal for a revised Conceptual Framework contains the following eight chapters:

Chapters 1 & 2: The objective of general purpose financial reporting and Qualitative characteristics of useful financial information
Chapter 3: Financial statements and the reporting entity
Chapter 4: The elements of financial statements
Chapter 5: Recognition and derecognition
Chapter 6: Measurement
Chapter 7: Presentation and disclosure
Chapter 8: Concepts of capital and capital maintenance

Some of the areas which are indicated as being new or additional compared to the existing framework are the sections dealing with:

  • Presentation and disclosure – with a focus on the objective and scope of financial statements, classification and aggregation and the overall achieving of effective and efficient communication
  • Derecognition, - guidance aimed at providing a faithful representation of (a) the assets and liabilities retained after a transaction or other event that led to derecognition, and (b) the change in the entity’s assets and liabilities as a result of that transaction or other event
  • The reporting entity – the IASB proposes guidance outlining that a reporting entity does not necessarily have to be a legal entity and can comprise only a portion of an entity, or two or more entities, with further comment on the basis of consolidation.

Presentation of Financial Performance
The IASB proposes, for the first time, to provide conceptual guidance on whether to present income and expenses in profit or loss or in other comprehensive income (OCI).
The European Financial Reporting Advisory Group (EFRAG) considers that the Framework should include more guidance in this area and has published a Bulletin which is an attempt to help the IASB to fill the void that it considers is in the ED on this issue. The Bulletin builds on a number of preceding EFRAG publications, including:-

  • The role of the business model in financial reporting
  • The nature of the enitity’s business activities
  • The reporting of income and expense and the choice of measurement bases

The EFRAG Bulletin has a particular focus on the Business Model. Similar assets and liabilities may be managed in different ways following different business decisions which result in different streams and timing of cash flows. To provide useful information, financial performance reporting should represent as faithfully as possible those differences, to help users in their assessments of the timing and amount of future cash flows. The Conceptual Framework could contribute very positively to how this is presented in the financial statements.
The Financial Reporting Lab (part of the FRC in the UK) has recently announced it is undertaking a series of projects considering the following interrelated areas of disclosure:

  • Business model reporting
  • Principal risk reporting
  • Viability statement reporting

The series of projects is expected to assist companies to understand how the investment community is using the disclosures in their decision making processes, what information is most useful and how it may be best presented. It will provide the investment community with a better insight into the process by which companies develop and use their business model, and is an opportunity for the investment community to influence reporting in this area.

Matters of Debate

Matters that may have appeared to recede into the background have come to the fore again with the IASB now proposing to:

  • Place more emphasis on the importance of providing information needed to assess management’s stewardship of the entity’s resources
  • Reintroduce an explicit reference to the notion of prudence (described as the exercise of caution when making judgements under conditions of uncertainty) and state that prudence is important to achieve neutrality and hence, a truthful representation

The Financial Reporting Council (FRC) has commenced its consideration of the ED and welcomes proposed changes including those in the areas outlined above. The FRC is however of the view that further improvements could be made to bring greater clarity and firmness to what is being proposed. 

The FRC’s initial considerations and resulting comments include:-

  • It is often the case that investors will need information that enables them to assess the success of management’s current strategies and to consider possible alternatives. To secure this, the Framework should either identify the provision of information on stewardship as a primary objective of financial reporting or expand its discussion of the issue. The FRC considers that a general statement that stewardship information is necessary to meet the objectives of financial reporting would result in a more coherent framework.
  • The Basis for Conclusions in the ED explains that asymmetric prudence is reflected in many current accounting standards and that accounting policies are consistent with the ED. Asymmetric prudence is the recognition of losses and liabilities at a lower level of likelihood (and hence often earlier) than gains and assets. The FRC is firmly of the view that this concept should be outlined in the main body of the Framework, not just in the Basis for Conclusions. This would not require that future Standards would invariably reflect asymmetric prudence - this would be a judgement made in the development of individual standards.

The Conceptual Framework is a major foundation stone in developing IFRS and may be of substantial assistance with their application and understanding. Our article highlights some of the more significant issues being addressed in the proposed revisions to the Framework, which are wide-ranging. It should also be borne in mind that the Framework project is taking place when there is other work being carried out by the IASB in this overall area, perhaps most notably the Disclosure Initiative, and also numerous projects being carried out by national standard setters, including the FRC’s Financial Reporting Lab.

For preparers, auditors, regulators and others involved with the accounts preparation and reporting process, it is worth investing time to gain some understanding of the fundamentals within the proposed Framework and other initiatives in order to improve your awareness of the context and direction of financial reporting.

A summary of the ED and some insightful observations may be found in the Deloitte Global publication IFRS in Focus.

The IASB have created a series of webcasts to help people gain an understanding of the proposals for a revised Framework.

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