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Harmonisation or Discord? The Critical Role of the IASB’s Conceptual Framework Geoff Whittington CFPA, Judge Business School, Cambridge.

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Presentation on theme: "Harmonisation or Discord? The Critical Role of the IASB’s Conceptual Framework Geoff Whittington CFPA, Judge Business School, Cambridge."— Presentation transcript:

1 Harmonisation or Discord? The Critical Role of the IASB’s Conceptual Framework Geoff Whittington CFPA, Judge Business School, Cambridge

2 The Success of IFRS in Harmonisation EU adoption, 2000 and 2005 Adoption in Australia and other individual countries (>100 use IFRS in some form) Convergence with USA (Norwalk Agreement, 2002, Roadmap 2005, SEC abandons reconciliation, 2007) Convergence with Japan, China, etc. Projected adoption by Canada, Brazil, India etc.

3 The Demand for Harmonisation Globalisation of Business: Lower costs for preparers and users. Higher confidence (lower cost of capital? Evidence is success of IASC (voluntary)

4 But Discord also EU ‘carve-outs’ of IAS 39 (portfolio hedging and Fair Value option) National restrictions of options (Australia) Anxiety over multiple interpretations, other than IFRIC (SEC oversight of foreign registrants) Variable enforcement standards

5 Why Discord? Transition implies big changes (EU), but once-for-all Control and Sovereignty: Ideally, everybody should use the same standard….. and it should be mine Underlying these are different cultures and institutions, which lead to different basic concepts, explicit or implicit ( Zeff 2007) Explicit conceptual frameworks focus these differences

6 The Role of the Conceptual Framework Harmonisation: Consistency between standards Comparability across entities Comprehensiveness (filling gaps: IAS8 ) Principles base ( simplicity and flexibility) Discord over choice of concepts

7 The IASB/FASB Conceptual Framework Revision Essential for convergence (and improvement) Existing IFRS Framework is similar to FASB, but shorter and some important differences Many new adopters had not ‘bought in’ to existing Framework and are objecting to that (‘ Anglo-Saxon accounting': reinforced by FASB convergence)

8 The Revision Programme A Objectives and qualitative characteristics ( DP published, ED pending) B Elements and recognition (active on elements) C Measurement (active, but not imminent) D Reporting entity (active, DP pending) E Presentation and disclosure (inactive) F Purpose and status (undetermined output) G Application to not-for-profit (inactive) H Remaining issues (tbd)

9 Some Discordant Themes Chapters 1&2, discussion papers, received a hostile reception that surprised IASB The central issue is stewardship, but the underlying cultural differences will affect later chapters.

10 Objective of Financial Reporting (Chapter 1) Focus on Present and Future Investors for Decision- making purposes, amongst the wider community of users. This leads to a focus on pricing in financial markets. Prediction of future cash flows the main objective. Stewardship assumed to require same information.

11 What’s Special about Stewardship? Alternative View to Chapter 1 Stewardship relates to accountability of management for past decisions: an agency relationship. Present shareholders have a special relationship as proprietors. Reference: Andrew Lennard, Accounting in Europe. Non-investor users may also have stewardship needs.

12 Implications for Financial Reporting Stewardship does not rule out current values or information relevant to future cash flows, so it overlaps with decision-usefulness. Emphasis differs and can lead to different accounting choices. Stewardship requires past transactions and events to be reported. It also recognises that the agent may be tempted to mislead, so that prudence may have a role. In the extreme, stewardship may require different information, e.g. related party transactions, directors’ remuneration. Future cash flows may be endogenous: interaction between proprietors and management is affected by financial reports.

13 Evidence of Cultural Origins Tim Bush, Divided by a Common Language. US accounting regulation based on securities law (market orientation) but UK based on company law (shareholder orientation). The USA has the deepest and most liquid markets and the most active market for corporate control. Hence FASB’s market orientation is unsurprising. Continental Europe has a tradition of control through two-tier boards, bank ownership etc., with few take-overs and less active stock markets. The UK and Australia are nearer to the USA: hence, ‘Anglo Saxon Accounting’. Continental European objections, articulated by EFRAG, also support stewardship, but wider range of stewards: tax, dividends, etc. (Zeff 2007).

14 Why does it matter? The rest of the Conceptual Framework and many more practical issues in standards are affected by the objective, e.g. measurement. Investor orientation leads to entity rather than proprietary orientation (present shareholders less important) Chapter 2, is ‘Qualitative Characteristics of Decision-Useful Financial Information

15 Qualitative Characteristics (Chapter 2) Old framework based on trade-off between relevance and reliability New framework (Chapter 2) proposes sequential choice starting with relevance Reliability replaced by representational faithfulness, indicating concern with substance of an economic phenomenon, i.e. decision relevance rather than stewardship prevails?

16 Other Characteristics Conservatism and Prudence are now explicitly excluded. Prudence was previously in the IASB framework. This detracts from stewardship, e.g. how can we justify impairment tests? (as in IFRS3, Business Combinations).

17 Elements and Recognition Changes in asset & liability definitions to exclude expected benefits and past transactions and events. Erosion of recognition criteria : Element definition changes Reliable measurement Benefits will probably flow to the entity

18 Importance of Recognition Criteria A filter for inclusion in accounts, consistent with stewardship. Decision usefulness may be satisfied by a valuation test: uncertainty in measurement. IAS 37 revision (liabilities) illustrates differences.

19 IAS37 Revision Provisions now to be called liabilities. Contingent liabilities dealt with by stand-ready obligations (uncertainty in measurement). No probability criterion. But where is element uncertainty?

20 Liability/equity distinction A practical issue in IAS32, ‘shares to the value of’’ and proposed IAS39 revision for puttable instruments. Present ‘non cash settled’ equity definition has failed. But what is the alternative? (narrow equity suits stewardship/proprietary view). Practical consequences in classification of and dealings with minority interests.

21 FASB’s alternatives for Equity definition (Nov DP) Narrow Equity, “Ownership”: the preferred method Broad equity, “Ownership/Settlement” “Reassessed Expected Outcomes” (REO) approach, with bifurcation of all credits bearing ownership risk.

22 AND Related Projects Revenue Recognition Financial Statement Presentation

23 Revenue Recognition A separate project, but really conceptual (Revenue is an element) Is the obligation to a customer based on Fair Value (measurement model), or an entity-specific cost of discharge (customer consideration model)?

24 Financial Statement Presentation Started before Section E of the CF. Comprehensive Income in a single statement. Is there to be a profit sub-total? Re-cycling banned? Cohesiveness between financial statements.

25 AND Things to Come Measurement: Resistance to Fair Value. Alternative can be replacement cost, not just historical cost. Cost based measures are consistent with stewardship and the going concern assumption, made in the present framework…but not in the revision. What is the market setting? (Whittington 2008). Measurement or Information?

26 Conclusion If you start from the wrong place, it will be more difficult to arrive at the right destination. Is the present decision-usefulness objective the right place?


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