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Page 1 12 December 2005

30 Cannon Street, London EC4M 6XH, England International

Phone: +44 (0)20 7246 6410, Fax: +44 (0)20 7246 6411 Accounting StandardsEmail: [email protected] Website: http://www.iasb.org Board

This document is provided as a convenience to observers at IASB meetings, to assist them infollowing the Boards discussion. It does not represent an official position of the IASB. Board

positions are set out in Standards.

These notes are based on the staff papers prepared for the IASB. Paragraph numbers correspondto paragraph numbers used in the IASB papers. However, because these notes are less detailed,

some paragraph numbers are not used.

INFORMATION FOR OBSERVERS

IASB Meeting: 13 December 2005, London (Agenda Paper 2)

Project: Conceptual Framework

Qualitative Characteristics 6: Costs and Benefits

Introduction

1. This paper continues consideration of the qualitative characteristics of accounting

information. In May and June, the Boards considered the definitions of the

qualitative characteristics of relevance, faithful representation, understandability,

and comparability, as well as whether other candidates for qualitative characteristics

needed to be considered. The Boards also considered the role of materiality. In July,

September, and October, the Boards considered relationships between those

qualitative characteristics identified in May and June. This paper examines the one

remaining topic being considered under qualitative characteristics, whether the

benefits of an accounting standard justify the costs involved.

2. The cross-cutting issue addressed in this paper is:

QC13: Cost/benefitdo the qualitative characteristics, especially the cost-benefit

balance, differ for different entities, e.g., large/small, listed/unlisted, widely

dispersed ownership vs. closely held?

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IASB/FASB December 2005

Qualitative CharacteristicsCosts and Benefits


3. This paper focuses primarily on one aspect of that cross cutting issueassessing for

all entities whether the benefits justify the costs involvedrather than on the

differences between different entities, which was the subject of a separate paper

discussed at the October 2005 joint meeting.

4. This paper begins with the existing discussions of this matter in the current IASB

and FASB frameworks, summarizes various research and recent developments

concerning cost-benefit analysis in financial reporting, and concludes with a

recommendation. Also included, for your convenience, is an Appendix 1

summarizing Board decisions to date. Appendix 2 [omitted from observer notes]

contains excerpts from a 1991 FASB publication,Benefits, Costs, and

Consequences of Accounting Standards.

5. The staff requests the Boards approval to proceed to draft material for an Exposure

Draft based on the discussion in this paper.

Cost-Benefit in the Current Frameworks

6. The IASB Frameworksays:

44. The balance between benefit and cost is a pervasive constraint

rather than a qualitative characteristic. The benefits derived from information

should exceed the cost of providing it. The evaluation of benefits and costs is,

however, substantially a judgmental process. Furthermore, the costs do not

necessarily fall on those users who enjoy the benefits. Benefits may also be

enjoyed by users other than those for whom the information is prepared; for

example, the provision of further information to lenders may reduce the

borrowing costs of an enterprise. For these reasons, it is difficult to apply a

cost-benefit test in any particular case. Nevertheless, standard-setters in

particular, as well as the preparers and users of financial statements, should be

aware of this constraint.

7. That paragraph makes the following points:

Cost-benefit is a constraint, not a qualitative characteristic.

Costs often fall on parties that do not benefit.

The evaluation is judgmental, and difficult to apply.

8. FASB Concepts Statement 2 says that, and quite a bit more. The entire discussion

is reproduced below, footnotes included, with emphasis added on certain points:

Hierarchy of Accounting Qualities: Pervasive Constraint: Benefits > Cost

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134. Unless the benefits to be derived from a commodity or service exceed

the costs associated with it, it will not be sought after. When a decision to

acquire a commodity is being considered, the prospective buyer will compare

the costs of acquisition and maintenance with the benefits of owning the

commodity. Once the purchase has been made, the owner must decide

continually, from day to daywhether the opportunity cost of ownership, the

sacrifice of the sale price that cannot be realized so long as ownershipcontinues, is less than the benefits of continued ownership. Thus, both before

and after acquisition, costs and benefits must be compared, though the

comparison takes a somewhat different form according to whether the

acquisition has or has not been consummated.

135. Financial information is unlike other commodities in certain

important respects. While, in general, it will not be desired unless its

benefits exceed its costs, what makes it different from other commodities, or at

least from those that are traded in the marketplace, is that whereas those other

commodities are private goods, to be enjoyed only by the buyer and those with

whom the buyer chooses to share them, the benefits of information cannot

always be confined to those who pay for it. If the whole government andprivate system by which the flow of financial information is regulated could

now be dismantled, if information could be traded between buyers and sellers

like other commodities and could be kept from those who did not pay for it,

and if consumers of information were willing to rely on their own inquiries,

the balance of costs and benefits could be left to the market. But in the real

world the market for information is less complete than most other markets,

and a standard-setting authority must concern itself with the perceived costs

and benefits of the standards it setscosts and benefits to both users and

preparers of such information, to others, like auditors, who are also concerned

with it, and to anyone else in society who may be affected.

136. Most of the costs of providing financial information fall initially onthe preparers, while the benefits are reaped by both preparers and users.

Ultimately, the costs and benefits are diffused quite widely. The costs are

mostly passed on to the users of information and to the consumers of goods

and services. The benefits also are presumably passed on to consumers by

assuring a steady supply of goods and services and more efficient functioning

of the marketplace. But, even if the costs and benefits are not traced beyond

the preparers and users of information, to say anything precise about their

incidence is difficult. There are costs of using information as well as of

preparing it; and much published information would be compiled for the

preparer's own use even if providing it to stockholders and others were not

required. The preparer enjoys other benefits also, such as improved access to

capital markets, favorable impact on the enterprise's public relations, and soon.

137. The costs of providing information are of several kinds, including costs

of collecting and processing the information, costs of audit if it is subject to

audit, costs of disseminating it to those who must receive it, costs associated

with the dangers of litigation, and in some instances costs of disclosure in the

form of a loss of competitive advantages vis-a-vis trade competitors, labor

unions (with a consequent effect on wage demands), or foreign enterprises.

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The costs to the users of information, over and above those costs that preparers

pass on to them, are mainly the costs of analysis and interpretation and may

include costs of rejecting information that is redundant, for the diagnosis of

redundancy is not without its cost.

138. Society needs information to help allocate resources efficiently, but the

benefit to any individual or company from that source is not measurable. Noris the spur to efficiency that comes from making managers account to

stockholders capable of evaluation, either at the level of the enterprise or the

economy. It is impossible to imagine a highly developed economy without

most of the financial information that it now generates and, for the most part,

consumes; yet it is also impossible to place a value on that information.

139. From the point of view of society, the loss of competitive advantage

that is said to result from some disclosure requirements is clearly in a different

category from the other costs involved. Although the loss to one business

enterprise may be a gain to another, the Board is aware of and concerned

about the economic effects of the possible discouragement of initiative,

innovation, and willingness to take risks if a reward to risk taking is denied.

That is another cost that is impossible to begin to quantify.

140. The burden of the costs and the incidence of benefits fall quite

unevenly throughout the economy, and it has been rightly observed that ". . .

the matter of establishing disclosure requirements becomes not only a

matter of judgment but also a complex balancing of many factors so that

all costs and benefits receive the consideration they merit. For example, a

simple rule that any information useful in making investment decisions should

be disclosed fails as completely as a rule that says disclosure should not be

required if competitive disadvantage results."1

The problem is to know how to

accomplish that "complex balancing."

141. The Board has watched with sympathetic interest the efforts of the

Cost Accounting Standards Board (CASB) to come to grips with the task of

comparing the costs and benefits of its standards. The Report of the special

group of consultants who were asked by the CASB to examine this matter was

submitted on November 13, 1978. The conclusions were quite negative.

Our conclusion is that no objective cost benefit calculation in

aggregate quantitative terms is possible for CASB standards as a

whole or for any of them individually. Reasonable people, with some

experience in such matters, acting responsibly in a spirit of

compromise, using such reliable information as can be gathered

together, will make a "calculation," as they must if anything is to be

done. But the calculation will be in ordinal rather than cardinal

terms; it will be rough rather than precise; it will always be subject torevision, rather than fixed in stone. The situation is not different from

that concerning the merits of many other laws, rules, regulations, and

administrative decisions. Nor is our conclusion different from the

1R. K. Mautz and William G. May, Financial Disclosure in a Competitive Economy (New York: Financial

Executives Research Foundation, 1978), p. 6.

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conclusion reached by those concerned with the cost-benefit problem

confronting the Paperwork Commission, for example.2

142. As the CASB's consultants point out, the reasons for that negative

conclusion can be simply stated. The costs and benefits of a standard are both

direct and indirect, immediate and deferred. They may be affected by a

change in circumstances not foreseen when the standard was promulgated.There are wide variations in the estimates that different people make about the

dollar values involved and the rate of discount to be used in reducing them to a

present value. "For these reasons," the consultants conclude, "the merits of

any Standard, or of the Standards as a whole, can be decided finally only

by judgments that are largely subjective. They cannot be decided by

scientific test."

143. Despite the difficulties, the Board does not conclude that it should turn

its back on the matter, for there are some things that it can do to safeguard the

cost-effectiveness of its standards. Before a decision is made to develop a

standard, the Board needs to satisfy itself that the matter to be ruled on

represents a significant problem and that a standard that is promulgated will

not impose costs on the many for the benefit of a few. If the proposal passes

that first test, a second test may subsequently be useful. There are usually

alternative ways of handling an issue. Is one of them less costly and only

slightly less effective? Even if absolute magnitudes cannot be attached to

costs and benefits, a comparison between alternatives may yet be possible and

useful.

144. Though it is unlikely that significantly improved means of measuring

benefits will become available in the foreseeable future, it seems possible that

better ways of quantifying the incremental costs of regulations of all kinds

may gradually be developed, and the Board will watch any such

developments carefully to see whether they can be applied to financial

accounting standards. Even if that hope proves to be a vain one, however,the Board cannot cease to be concerned about the cost-effectiveness of its

standards. To do so would be a dereliction of its duty and a disservice to its

constituents.

9. Those 11 paragraphs from the FASB framework make the following points:

Cost-benefit is a pervasive constraint, not a qualitative characteristic [same as

IASB Frameworks first point].

The costs of providing financial information fall initially on the preparers,

while the benefits are reaped by both preparers and users [much the same as

IASB Frameworks second point]. Financial information is unlike other commodities in not being a private good,

to be enjoyed only by the buyer and those with whom the buyer chooses to

share them.

2Robert N. Anthony et al, "Report to the Cost Accounting Standards Board by a Special Group of

Consultants to Consider Issues Relating to Comparing Costs with Benefits", (1978), p. 1.

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It is impossible to place a value on the financial information used to allocate

resources efficiently, the main benefit of financial accounting standards.

It is impossible to quantify the cost of the loss of competitive advantage that is

said to result from some disclosure requirements.

The merits of any standard can be decided finally only by judgments that are

largely subjective. They cannot be decided by scientific test. Any calculationwill be in ordinal rather than cardinal terms, rough rather than precise, and

subject to revision. The situation is not different from that concerning the

merits of many other laws, rules, regulations, and administrative decisions.

[an expansive version of the third point in the IASB Framework].

10. The first two points shared by the present frameworks still seem appropriate, and

relatively uncontroversial, (although perhaps more emphasis is needed on the costs

to users of having to ferret information out from incomplete, obscure, or poorly

presented financial statements.) The staff recommends that the first two points

be carried over in the converged framework. However, the third shared point

needs some reconsideration, as do the other points made in the FASB discussion.

The balance of this paper reconsiders those points.

Is Cost-Benefit Analysis Too Difficult to Apply in Standard Setting?

11. Both frameworks say or imply that, for accounting standard setting, rigorous cost-

benefit analysis is too difficult to apply. They also say that the evaluation of

whether the benefits of a financial reporting requirement justify the resulting costshas to be judgmental. They provide some logical arguments for why that should be

so, but no proofs.

12. In the basis for conclusions of their standards, both Boards typically mention cost-

benefit considerations briefly, and judgmentally. The FASB often discusses those

considerations explicitly in a separate section. The IASB is less explicit. For

example, in recent standards on stock-based compensation:

The FASB, in a separate section of its basis for conclusions, said that the

value of that incremental improvement to financial reporting and most ofthe costs to achieve it are subjective and cannot be quantified. It went on

to discuss procedures followed in assessing preparers costs, including a

field visit program, a survey of commercial software providers, and

discussions with valuation experts, plus interviews with nonpublic entities.

It concluded that, based on the findings from those procedures, the

Statement will sufficiently improve financial reporting to justify the costs

it will impose, and went on to enumerate some decisions intended to

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mitigate costs of compliance for some preparers. No dollar amounts or

relative magnitudes of costs or benefits were given.

The IASB did not separately discuss cost-benefit considerations.

However, the IASB staff that managed that project recalls that cost-benefit

considerationssometimes under the label of practicalityaffected

many of the decisions. For example, the Board chose to measureemployee services not directly, but indirectly at the fair value of equity

instruments granted, adopted the modified grant-date method instead of a

units-of-service method that constituents found too complicated, and

allowed the use of the relatively simple Black-Scholes-Merton model, all

of which reduced costs of compliance for preparers. No dollar amounts or

relative magnitudes of costs or benefits were given.

13. Another procedure that is concerned in part with costs and benefits or practicability,

though not necessarily described as such, is field testing of proposed standards. The

FASB has conducted at least 14 field tests over the years, the most extensive of

which focused on pensions and other post-employment benefits. Veterans of that

project recall that the field tests produced some information about the costs of

applying the proposed standards and the benefits of the resulting information that

the Board found useful in its redeliberations, and the preparers also benefited from

their participation by gaining a greater understanding of those obligations and about

the trade-offs between dampened volatility and the more complex accounting

procedures required to dampen the volatility. However, FASB Board members and

staff veterans also recall some field testing on other projects that proved less useful.

One reason for that lack of usefuless was that the costs and inconvenience of

conducting such tests makes it difficult to recruit voluntary participants, and

voluntary tests will suffer from self-selection bias, while neither Board has the

power to compel participation. Another reason is that the efforts put into an effort

that is only a test rarely are as thorough as when a company must produce real

numbers. The staff of this project does not recommend concepts that imply that the

Boards should conduct field testing on standards projects.

14.

The Boards often receive comments from constituents suggesting that benefits of

proposed standards do justify costsor more often that they do not. Sometimes

the Boards explicitly request comments on that matter, but usually not.

15. Other standard setters have (or have not) considered cost-benefit concepts:

Australias Concepts Statement 3 discusses cost-benefit in much the same way

as the FASB and IASB. It calls for efforts to assess cost and benefit, but

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makes the same points that costs should not exceed benefits, costs and benefits

fall on different parties, and assessing them is difficult and ultimately relies on

judgment.

Canadas Handbook also is similar, saying that the benefits expected to arise

from providing information in financial statements should exceed the cost of

doing so. In developing accounting standards, the Board weighs the

anticipated costs and benefits of its proposals in general terms . . . . and notesthe need for judgment. Canada has a differential reporting standard, which

also includes cost-benefit tests.

New Zealands cost-benefit concepts are virtually identical to those of the

IASB. In applying those concepts to the issue of differential reporting for

small or private companies, the New Zealanders made the broad assumption

that:

(a) More benefits are derived from the general purpose financial

reports of entities with public accountability because the reports of such

entities are likely to have more users.

The Japanese discussion paper says that, Accounting standards should be

determined based on whether the objectives of financial reporting can be

achieved efficiently (paragraph 21) and that a balance must be considered

between imposing costs of renegotiating contracts due to changes in

accounting standards imposed on the majority of constituencies who are not

involved in those contracts and the benefits associated with the changes

(paragraph 22). The paper excludes consideration of cost-benefit from the

discussion of qualitative characteristics, saying that there is doubt of its

significance and that it is self-evident.

The UK ASBs Statement of Principles, in contrast, does not discuss cost-

benefit considerations in its chapter on qualitative characteristics or elsewhere,

not even its appendixes comparing it to the IASB Frameworkand givingbackground. However, in their FRSSE, the ASB did consider cost-benefit,

saying that, among other factors:

(g) The standard or requirement provides the least cumbersome method

of achieving the desired accounting treatment and/or disclosure for an

entity that is not complex.

(h) The standard provides guidance that is expected to be widely relevant

to the transactions of small entities and is written in terms that can be

understood by such businesses.

(i) The measurement methods prescribed in the standard are likely to be

reasonably practical for small entities.

16. [Paragraph omitted from Observer Notes]

Will More Rigorous Cost-Benefit Analysis Be Forced Upon the Boards?

17. Strong suggestions for just that are coming. One recent example is a June 2005

decision in the U.S. Federal courts on a lawsuit brought by the U.S. Chamber of

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Commerce against the SEC. The issue was not a financial reporting matter, but the

decision, now final after completion of the appeals process, has a broad effect on all

SEC rulemaking conducted under the Administrative Procedures Act (APA). In

that case, the courts decided that the SECs claim that it was without a:

reliable basis for determining how funds would choose to satisfy the

[condition] and therefore it [was] difficult to determine the costs . . . does

not excuse the Commission from its statutory obligation to determine as

best it can the economic implications of the rule [even in the] face of

uncertainty. Uncertainty may limit what the Commission can do, but it

does not excuse the Commission from its statutory obligation to do what it

can to apprise itself and hence the public and the Congress of the

economic consequences of a proposed regulation before it decides whether

to adopt the measure. . . . In sum, the Commission violated its obligation

under. . . the APA, in failing adequately to consider the costs imposed

upon funds.

18. The decision does not address what the SEC needs to do to assess the benefits, or to

judge whether benefits justify costs.

19. At least partly as a result of that court case, the SECs cost-benefit analysis on

financial reporting matters has become much more extensive. For example, in an

April 2005 amendment to its rules on first-time application of international financial

reporting standards, the SEC included several pages of detailed paperwork impact

analysis that reported estimated hours of work by preparers to apply the standards

and the estimated reductions in workload from the accommodations in that

amendment. Also, the SEC included in that amendment a less quantitative, but still

extensive, cost-benefit analysis that said the following:

V. COST-BENEFIT ANALYSIS

In the Proposing Release, the Commission solicited comments on the expected

costs and benefits of the proposed amendments to Form 20-F, as well as on any

other costs and benefits that could result from the adoption of those proposed

amendments. In response, commenters expressed widespread support for the

relief that the proposal would provide . . . . However, several commentersmaintained that the proposals regarding condensed U.S. GAAP financial

information and financial statements for interim periods during the Transition

Year would impose costs on 50 foreign private issuers that were unnecessary to

achieve the rules purpose and that outweighed the potential benefits to

investors. The Commission has modified the final amendments in response to

these concerns, thereby eliminating some of the potential costs that issuers may

have incurred under the amendments as proposed.

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Although none of the commenters provided quantitative data to support their

views, the Commission has revised the amendments to Form 20-F in response to

the concerns that the commenters expressed. The Commission expects that the

adopted amendments to Form 20-F will result in the following benefits and

costs.66

66 It is estimated these amendments will affect approximately 400 foreign private issuers.

A. Expected Benefits

The amendments to Form 20-F will benefit foreign private issuers that adopt

IFRS, either voluntarily or by mandate, by facilitating their compliance with

SEC disclosure requirements as those issuers transition from their Previous

GAAP to IFRS. By permitting eligible issuers to provide two rather than three

years of financial statements prepared in accordance with IFRS, the amendments

will allow those issuers to avoid the retroactive application of accounting

standards that may not have been finalized during the earliest reporting period to

which they would have to be applied in order to provide financial statements

that were in compliance with SEC filing requirements.

By eliminating the third year of IFRS financial statements, the accommodation

also benefits issuers by aligning SEC requirements with the IFRS 1 standard,

which requires only one year of comparative information for the year IFRS is

adopted. Through the amendments to Form 20-F, the Commission is eliminating

the need for financial statements that would have been required by SEC rules

but not otherwise. In years after their Transition Year, when the accommodation

will no longer apply, issuers will have available IFRS financial statements for

the financial year that they were permitted to exclude under the accommodation.

The amendments also will benefit investors in several ways. First, the

accommodation will improve the clarity and quality of the financial disclosure

that first time adopters of IFRS provide in their SEC filings, thereby enhancing

investor understanding. By clarifying the level of information required in thereconciliation of previous GAAP information to IFRS, for example, the

amendments will provide investors with a comparable level of reconciliation

information between companies that will enable them to understand the material

impact of the switch to IFRS on each issuers financial statements.

The accommodation also is expected to benefit investors by encouraging the use

of IFRS as a high quality body of accounting principles designed to accurately

reflect the issuers financial position. By reducing the burden of financial

reporting in registration statements filed by first-time adopters of IFRS, the

accommodation will encourage those issuers either to enter or to continue their

participation in the U.S. capital market, which will further benefit investors by

increasing their investment possibilities. These benefits will likely lead to a

more efficient allocation of capital.B. Expected Costs

The amendments to Form 20-F could result in some costs to issuers relying on

the accommodation, although those costs should be minimal as they relate

principally to how information required under rules existing prior to these

amendments should be presented when based on primary financial statements

based on IFRS. One area in which issuers relying on the accommodation may

face increased cost relates to the provision of interim financial statements. The

Commission has adopted a flexible approach that provides an issuer with a

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22. Increasing demand for cost-benefit analysis is not just a United States matter. It is

an increasing theme in Europe. For example, in its very detailed 135-page Guide to

Cost-Benefit Analysis for Investment Projects, the European Commission includes

instructions like this one on page 32:

2.5.3 Phase 3 - From market to accounting prices.The objective of this phase is to determine the column of conversion

factors for the transformation of market prices into accounting prices.

Project examiners should check if the projects proposer has considered

social costs and benefits of the project in addition to financial costs and

benefits.

Accounting prices, market prices, accrual accounting, and social costs and benefits

are all defined in a glossary, and a nearby table provides an Example for the

calculation of the standard conversion factor for price distortion of inputs and

outputs.

23. The TransAtlantic Business Dialogue is a group of chief executives from

American and European companies operating in the United States, Europe, and

globally that was originally convened by the U.S. Department of Commerce and the

European Commission in Seville in 1995. In its report to the 2005 EU-US Summit,

the group endorsed measures to increase confidence in financial reporting

including convergence of US standards . . . with IFRS, but also said that

governments and regulators should be:

2. Avoiding the creation of new barriers [by]

Creat[ing] a template for common impact assessments, including cost-benefit

analysis, to evaluate the potential effects of proposed regulations on the

transatlantic market.

Discuss[ing] science-based approaches to rule making, such as risk

assessment and risk management, with a view towards highlighting ex-ante

divergences between US and EU regulators across business sectors. (Page 9)



26. At the U.S. Federal government level, cost-benefit analysis remains a work in

progress, as indicated by a Government Accountability Office (GAO) report, issued

in July 2005, on its December 2004 workshop on economic performance measures.

The workshop was convened to:

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Discuss the present state of economic performance measures, such as cost-

benefit analysis and cost-effectiveness assessment, and identify gaps in their

application and the barriers and analytical issues that limit their use in helping

assess the performance of federal programs

Identify opportunities for the federal government and professional and academic

institutions to improve (1) the use of economic performance measures for

evaluating federal programs and (2) the general economic principles and

guidance on which economic performance analysis is based.

The GAO reported that prospective analyses are often incomplete and inconsistent

with general economic principles and are often not useful for comparisons across

the government, because they are often based on different assumptions for the same

key economic variables.

Participants identified gaps in the application of economic performance measures:

1. Economic performance measures are not widely used.

2. Performance of regulations or programs are often not assessed retroactively,

even though this information could be useful

Participants identified barriers that cause economic performance measures not to be

used and several analytical issues that require resolution before consistency and

credibility of economic performance measures can be improved:

Participants recommended that the Government:

1. Expand the use of economic performance measures, especially for retrospective

analysis of existing programs because such analysis could provide lessons on

how to improve prospective analysis of proposed programs.

2. Develop a minimum set of general economic principles and abbreviated

guidelines

3. Develop one-page summaries and scorecards of economic performance analysis

and use expert review to provide procedures and strategies.

4.

Standardize some key economic assumptions.

5. Develop an independent and flexible organization to provide guidance and

develop standards. Several participants expressed interest in the accounting

professions use of standard-setting authorities to develop comprehensive

principles and standards (emphasis added). Some participants indicated,

however, that professional economics institutions are not designed to govern or

monitor the application of economics.

27. Of course nothing is really new under the sun. The FASB has considered benefits

and costs with some intensity before this. In 1991, the FASB issued a Special

Report,Benefits, Costs, and Consequences of Financial Accounting Standards,

which discussed the role of cost-benefit considerations in the FASBs process and

the question of whether costs and benefits are measurable, among other topics. That

report was the result of a two-year look at costs, benefits, and consequences

prompted by criticism that the FASB was not doing enough to weigh those factors

in its decision making. Excerpts from that report (now out of print) are attached as

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Appendix 2. Excerpted are a discussion of benefits and costs authored by two then-

members of the FASB staff, Diana Scott and Wayne Upton (pages 119), a 1990

FASAC discussion asking Are Costs-Benefits Measurable? (pages 2135), and

another 1990 FASAC discussion about U.S. competitiveness and the benefits of

accounting standards (pages 49

58).

28. But no good report goes unpunished. A 1994 article by two accounting professors

took the authors of that special report, and the FASB, to task for downplaying the

cost-benefit constraint. The authors declared that, under the existing conceptual

framework the FASB is committed to rejecting a proposed standard if the costs of

that standard to all stakeholders equal or exceed the benefit to all stakeholders, even

if the implementation of that standard would result in more relevant and reliable

financial information. The authors claimed that language commits the Board to

consider economic and social consequences as part of the cost-benefit analysis, and

that the Board did not do that in Statement 106. (Martens, Stanley and Kevin

Stevens, The FASBs Cost/Benefit Constraint in Theory and Practice,Journal of

Business Ethics, March 1994, pp 171179.)

What Are Our Alternatives? And What Do They Imply for the Framework?

A. Do Very Little


30. That would call for conceptual language based on what the two frameworks say

today. To be brief, following along the lines of the IASB Framework, the

converged framework might say something like:

A pervasive constraint to financial reporting is that the benefits of required

information should justify the costs of providing and using it. [list types of

benefits, types of costs3] However, benefits are enjoyed primarily by users of

financial reporting information, while costs fall largely on those who prepare

that information. Information about benefits, in particular, and about costs isdifficult to obtain and likely to be incomplete. For those reasons, it is difficult

to apply a cost-benefit test in any particular case. Nevertheless, standard-

setters should continue to be concerned about the cost-benefit constraint in

conducting their deliberations.

3Concepts Statement 2, paragraph 37 (reproduced on page 3 of this paper) lists kinds of costs As

discussed in the Boards June meetings, the staff plans to use that as a starting point for drafting this

section.

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B. Commit to Requesting More Information


32. The framework could replace the existing language that explains why the Boards

cannot do much in the way of cost-benefit analysis with something more like:



benefits, types of costs] Standard-setters should seek information from

preparers, users, and other constituents about their expectations concerning the

nature and quantity of benefits and costs of proposed standards. While the

information about benefits, in particular, and about costs is likely to be

incomplete, standard setters should consider in their deliberations the

information they can obtain.

C. Commit to Conduct Actual Cost-Benefit Analysis

33. A more extensive alternative would be to commit standard setters to more active

efforts at cost-benefit analysis. That might be expressed, in concept, with

something more like:



benefits, types of costs] Standard setters should analyze benefits and costs of

proposed financial reporting requirements, including seeking information from

preparers, users, and other constituents about their expectations concerning the

nature and quantity of benefits and costs of proposed standards, taking steps to

verify the information received from constituents, and conducting research todevelop further necessary information. Standards should require financial

reporting information only if expected benefits of that information are shown

to exceed the expected costs involved in developing and using that

information.

Staff Recommendation

34. The staff recommends that the discussion of cost-benefit matters be enhanced, with

indications that the Boards should solicit information about costsand benefits

and find ways to use that information to support judgments that the benefits of a

proposed standard justify the costs. Alternative Aessentially unchanged language

in the framework indicating that we are standing patwill not be accepted by many

of our constituents.

35. How much to enhance it? The staff recommends alternative B, which commits us

to always request information and look at it, but not to verifying input from

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constituents, developing information in the absence of such input, or hiring staffs of

economists who have expertise in cost-benefit analysis. Setting out to do those

things, as alternative C would commit the Boards to do, might not be achievable and

would certainly extend the time table of every standards project; in other words, the

uncertain benefits of choosing alternative C would not justify the substantial costs

involved.

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APPENDIX 1

CONCEPTUAL FRAMEWORK

OBJECTIVES AND QUALITATIVE CHARACTERISTICS

Summary of Tentative Decisions Made in Prior Meetings

Sources: FASB Action Alert, IASB Update

OBJECTIVES

Objective of Financial Reporting

In the two Boards existing frameworks, the overriding objective of financial reporting is toprovide information to assist users in making economic decisions, such as making investment,

credit, and similar resource allocation decisions.

Liquidity and Solvency

Also, as discussed in the two Boards existing frameworks, the financial statements should

provide information to help users assess an entitys liquidity and solvency. However, that

objective should be consistent with the overall objective of providing information to a wide

range of users. Therefore, the information provided in the financial statements should not befocused upon meeting the information needs of particular types of users that primarily use the

financial statements to help them assess an entitys liquidity and solvency.

Stewardship and Accountability

The Board agreed that stewardship and accountability should not be a separate objective of

financial reporting by business entities in the converged framework. The Board agreed that theconverged framework should clearly describe its meaning of stewardship, which encompasses

managements responsibility not only for the custody and safekeeping of assets entrusted to it but

also for their efficient and profitable use. As a consequence, the Board agreed that the convergedframework should clarify that financial information useful for making investment, credit, and

similar resource allocation decisionsthe primary objectiveand would include financial

information useful for assessing managements stewardship.

Financial Reports

The objective is to provide information about the entity to external users, that is, users who lackthe power to prescribe the information they require and therefore must rely on the information

provided by an entitys management. The entitys management also will be interested in that

information. However, because management has the power to obtain the information it requires,any additional information needs of management are beyond the scope of the framework.

As with the existing frameworks, the Boards converged framework should be concerned withgeneral purpose financial reports, which focus on the common information needs of users. That

does not preclude the Boards from concluding, in a standards-level project, that additionalinformation should be provided to meet the information needs of particular types of users.

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IASB/FASB December 2005 APPENDIX 1



Users

Financial reports should be prepared from the entitys perspective and should aim to provide

information to a wide range of users, rather than focus on the information needs of existing

common shareholders only. The framework should identify the primary users as present andpotential investors and creditors (and their advisors).

Later in the project, the Boards will consider whether financial reporting also should provideinformation to meet the information needs of particular types of users, such as different types of

equity participants.

Planning Issues for Discussion of Prospective Financial Information

The Board agreed that it should continue with the original plan to issue a due process document

on objectives and qualitative characteristics (Phase A) before consideration of prospective

financial information. That due process document should indicate that the Board will considerthe topic of prospective financial information in the later phase on presentation and disclosure,

including the boundaries of financial reporting (Phase E). At the October 25, 2005 joint meeting,

the Boards decided the initial due process document would be an Exposure Draft.

QUALITATIVE CHARACTERISTICS

Relevance is an essential qualitative characteristic. To be relevant, information must be capableof making a difference in the economic decisions of users by helping them evaluate the effect of

past and present events on future net cash inflows (predictive value) or confirm or correct

previous evaluations (confirmatory value), even if it is not now being used. Being capable of

making a difference, rather than now being used, is a change from the present IASB Framework;confirmatory rather than feedback value is a change from the present FASB Concepts

Statements. Also, the information must be available when the users need it (timeliness).

Accounting information haspredictive value if users use it, or could use it, to make predictions.

Accounting information is not intended in itself as a prediction, nor as synonymous with

statistical predictability or persistence.

Faithful representation of real-world economic phenomena is an essential qualitative

characteristic, which includes capturing the substance of those economic phenomena.

Representations are faithfulthere is correspondence or agreement between the accounting

measures or descriptions in financial reports and the economic phenomena they purport torepresentwhen the measures and descriptions are verifiable and the measuring or describing is

done in a neutral manner. Therefore, faithful representation requires completeness, not

subordinating substance to form, verifiability, and neutrality. Consequently, the commonframework should drop the widely misinterpreted term reliability from the qualitative

characteristics, replacing it withfaithful representation. That replacement is a change from the

current IASB and FASB frameworks. The common conceptual framework will need to discussthoroughly what faithful representation means, and what it does not mean.

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Financial information needs to be verifiable to provide assurance to users that the information

faithfully represents what it purports to represent and that the information is free from materialerror, complete, and neutral. Descriptions and measures that can be directly verified through

consensus among observers are preferable to descriptions or measures that can only be indirectly

verified.

Financial information needs to be neutralfree from bias intended to influence a decision oroutcome. To that end, the common conceptual framework should not include conservatism or

prudence among the desirable qualitative characteristics of accounting information. However, the

framework should note the continuing need to be careful in the face of uncertainty.

Although empirical research may provide evidence useful in standard-setting decisions, forexample, in assessing trade-offs between desirable qualities, the conceptual framework project

should not seek to develop empirical measures of faithful representation or its component

qualities.

Understandability also is an essential characteristic of decision-useful financial information andshould be included in the converged conceptual framework. Understandabilityis the quality of

information that enables users, who have a reasonable knowledge of business and economicactivities and accounting and study the information with reasonable diligence, to comprehend the

meaning of the information.4

Information is made more understandable by aggregating,

classifying, characterizing, and presenting it in a clear and concise manner. Relevantinformation should not be excluded because it is too complex or difficult for certain users to

understand.

The converged framework should include presumptions not only about the capabilities of

financial statement users but also about the capabilities of financial statement preparers and

auditors.

Comparability is an important characteristic of decision-useful financial information and should

be included in the converged conceptual framework. Comparabilitywhich enables users to

identify similarities in and differences between economic phenomenashould be distinguished

from consistencythe consistent use of accounting methods. Concerns about comparability orconsistency should not preclude reporting information that is of greater relevance, or that more

faithfully represents the economic phenomena it purports to represent. If such concerns arise,

disclosures can help to compensate for lessened comparability or consistency.

Other Characteristics

Other possible characteristics considered, including transparency, credibility, high quality, and

internal consistency, do not describe attributes of decision-useful financial information that are

distinct from other qualitative characteristics. Thus, they should not be added as separatequalitative characteristics in the converged framework. Transparency, often cited recently as a

4 The staff has revised the wording of the proposed definition of understandability based on the recommendations

made by Board members during the July 2005 meetings.

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desirable characteristic of financial information, seems to be difficult to define. In current usage,

it appears to encompass some of the qualitative characteristics already included in theframeworks. Because it would be redundant, transparency should not be added to the converged

framework as a separate qualitative characteristic of decision-useful financial information.

Materialityrelates not only to relevance, but also to faithful representation. Materiality should beincluded in the converged framework as a screen or filter to determine whether information is

sufficiently significant to influence the decisions of users in the context of the entity, rather than

as a qualitative characteristic of decision-useful financial information.

Information is material if its omission or misstatement could influence the economic decisions of

users taken on the basis of the financial statements. Materiality depends on the nature andamount of the item judged in the particular circumstances of its omission or misstatement. Given

the pervasive nature of materiality, it is difficult to consider the concept except as it relates to the

qualitative characteristics of relevance and faithful representation. Thus, materiality is a screenor filter used to determine whether information is sufficiently significant to influence the

decisions of users in the context of the entity, rather than as a qualitative characteristic ofdecision-useful financial information.

Cost-benefit considerations may limit the information provided by financial reports. The

converged framework should include information about the types of costs that should beconsidered in deciding what financial information should be provided, as well as criteria to help

standard setters decide how to take particular types of costs into account. The converged

framework should include presumptions not only about the capabilities of financial statementusers but also about the responsibilities and capabilities of financial statement preparers and

auditors.

Relationships between Qualitative Characteristics of Financial Reporting

Board members observed that the different qualitative characteristics and their sub-qualitiessometimes suggest different answers to standard setting and financial reporting issues.

Previously, discussion of such differences has focused on hierarchy (that is, which characteristics

prevail over others because they are ranked higher) or bargaining (that is, how much of one

quality the Board is willing to "trade-off" to get more of another quality). The Boards agreed thatthey should consider the characteristics of financial reporting information as steps in a process

that results in decision-useful financial reporting. Board members suggested several

improvements to the description and illustration of the process proposed by the staff and the staffhas refined that process. The Boards decided that the process should be described as a process to

be used by standard setters.

Do the Objectives and Qualitative Characteristics Need to Differ for Particular Types of

Entities?

The Boards concluded that there is no need to modify the objectives of financial reporting orqualitative characteristics of decision-useful financial reporting for any types of private-sector

entities. The Boards acknowledged that there might be differences in how certain qualitative

characteristics are applied.

Documents

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