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Response to the IASB s Discussion Paper DP/2013/1 --

A Review of the Conceptual Framework for Financial Reporting

The Ad Hoc Committee of the International Association for Accounting Education and Research

Jannis Bischof, University of Chicago

Holger Daske, University of Mannheim

Elizabeth A. Gordon, Temple University

Paul Munter, KPMG

Chika Saka, Kwansei Gakuin University

Kimberly J. Smith, College of William and Mary

Elmar R. Venter, University of Pretoria

SUMMARY

In response to the IASB’s Discussion Paper DP/2013/1 -- A Review of the Conceptual

Framework for Financial Reporting we, the members of the Ad Hoc Committee of the

International Association for Accounting Education & Research (IAAER), are pleased to offer

our comments on the preliminary views on the the elements of financial statements, recognition

and derecognition, presentation and disclosure, and presentation of comprehensive income. The

views expressed are those of the authors and do not necessarily reflect a consensus view of the

IAAER membership or its Executive Committee.

The mission of the IAAER is to promote excellence in accounting education and research on a

worldwide basis and to maximize the contribution of accounting academics to the development

and maintenance of high quality, globally recognized standards of accounting practice.

Our comments are supportive of the IASB’s objective to develop one set of globally acceptable

accounting standards based on a cohesive and complete conceptual framework, and are delivered

with the intent to enhance the acceptability of IFRS worldwide.

INTRODUCTION

The purpose of this commentary is to offer a response on the preliminary views on a revised

Conceptual Framework proposed by the IASB. This review is conducted in the context of

concepts and principles already established in the Conceptual Framework (IASB, 2010a), in

particular, the objectives of general purpose financial reporting and the qualitative characteristics

of useful financial information. The purpose of this approach is to evaluate whether the proposed

concepts fit into a cohesive and complete Conceptual Framework in a manner which is internally

consistent (Barth, 2014).

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The Conceptual Framework establishes that the objective of financial reporting is to provide

financial information about a reporting entity that is useful to existing and potential investors, to

lenders and to other creditors who wish to make decisions about providing resources to the entity

(IASB, 2010a). The Conceptual Framework identifies the fundamental qualitative characteristics

of relevance (predictive value, confirmatory value or both) and faithful representation (complete,

neutral and free from error), and lists comparability, verifiability, timeliness and

understandability as enhancing qualitative characteristics (IASB, 2010a).

The Committee is pleased to respond to the IASB DP. The IASB DP is organized into 9 sections

and requests responses to 26 separate questions. Instead of answering each of the questions

separately, we summarize the DP’s preliminary views, offer a response, and then summarize

relevant academic research and insights related to the selected issues in areas where academic

research can inform standard setters. The related academic research is not a complete review of

the academic literature. Rather, we select literature we view as most pertinent. We would be

happy to expand and extend the review in areas in which the Board seeks additional information.

First, we provide an overview of the committee’s main comments and then offer specific

comments.

OVERVIEW OF THE COMMITTEE’S CONCLUSIONS

Our responses are based on the objective and qualitative characteristics of financial reporting that

are outlined in Chapters 1 and 3 of the existing Conceptual Framework, which we believe the

IASB should retain. The main conclusions we offer are to:

• support the preliminary view on the definitions of assets and liabilities. We also agree

that the Conceptual Framework should retain the existing definition of equity as the

residual interest in the assets of the entity after deducting all its liabilities.

• agree that all assets and liabilities should be recognized if they meet the definition of an

element.

• seek additional guidance on the role of uncertainty beyond what is currently in the

Preliminary Views.

• suggest that the view that the relevance of a particular measurement depends on how

investors, creditors and other lenders are likely to assess how an asset or a liability will

contribute to future cash flows merits additional consideration (Question 11 (e), 12 to

14).

• agree that the strict obligation approach is most useful for the distinction between equity

and liabilities and that the most subordinated class of instruments should be treated like

equity if an entity has issued no instruments that meet the definition under the strict

obligation approach.

• suggest that providing additional guidance on how to make disaggregation choices is of

critical importance for the revised Conceptual Framework.

• suggest that the definition of useful information in the context of the notes to the financial

statements should also be tied to the qualitative characteristics in Chapter 3 of the current

Conceptual Framework. Specifically, we believe that an important purpose of the notes

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to the financial statements is to ensure that combined financial statements and notes

reflect these qualitative characteristics.

• encourage the Board to further consider different types of forward-looking information

and then consider the appropriate placement.

• propose that current distinction between profit or loss and other comprehensive income

should not be retained. Therefore, the question of recycling becomes irrelevant. Instead,

the IASB should seek ways to improve the disclosure on remeasurements.

COMMENTARY ON SECTIONS OF THE DP

Section 1 Introduction

Preliminary Views: The DP presents the Board’s preliminary views that “the primary purpose of

the revised Conceptual Framework is to assist the IASB by identifying concepts that the IASB

will use consistently when developing and revising IFRSs.” The preliminary views also

emphasize that the Conceptual Framework does not override Standards and Interpretations, and

in rare cases the Board may decide to issue new or revised Standards that conflict with the

Conceptual Framework.

Response (Question 1): We agree that the purpose of the revised Conceptual Framework “is to

assist the IASB by identifying concepts that it will use consistently when developing and

revising IFRSs”. The IASB should aim to write standards that rely on and are consistent with the

Conceptual Framework. We also agree, though, that in those rare cases where the IASB may

decide to issue a new or revised Standard that conflicts with an aspect of the Conceptual

Framework, reasons for the departure should be explained. This explanation will assist

preparers, auditors, regulators, educators, and researchers to understand, explain, and implement

the standard.

Additionally, under IAS 8, Accounting Policies, Changes in Estimates and Errors, the

Conceptual Framework is part of the hierarchy of the authoritative accounting literature and is,

therefore, important to financial statement preparers.

Related Academic Literature and Discussion: Based on the notion that consistent accounting

standards improve comparability of accounting numbers across firms, the academic discussion

overwhelmingly supports principles-based financial reporting standards and is, thus, in favor of a

conceptual framework that guides the standard setter in future regulation. Evidence from

experiments and surveys suggests that, on average, managers tend to report more aggressively

and auditors accept the aggressive reporting behavior when rules-based standards lack a

comprehensive reporting objective (Nelson, Elliott, and Tarpley, 2003: Agoglia, Doupnik, and

Tsakumis, 2011). Note, however, that Schipper (2003) argues that guiding principles in a

Framework need to be accompanied by additional implementation guidance, i.e., rules-based

regulation, in individual standards to achieve the desired comparability.

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Sections 2 and 3 Elements of Financial Statements and Additional Guidance to Support the

Asset and Liability Definitions

Preliminary views: The DP preliminary views are that the Board should amend the definitions

of an asset and liability to more explicitly emphasize the underlying resource or obligation. The

IASB proposes the following definitions: (a) an asset is a present economic resource controlled

by the entity as a result of past events; (b) a liability is a present obligation of the entity to

transfer an economic resource as a result of past events; (c) an economic resource is a right, or

other source of value, that is capable of producing economic benefits. The definitions of an asset

and a liability are discussed in paragraphs 2.6–2.16.

Response (Question 2): Overall, we support the definitions of an asset and liability as they

appear in the preliminary views. These definitions maintain the balance between a broad

economic understanding of assets and liabilities, on the one hand, and an emphasis as being

under the control of the firm as a result of past events, which is consistent with their existence,

on the other hand. It is well established in theory on company valuation that firm value is the

discounted sum of its future cash flows (i.e., future benefits) and assets, net of liabilities,

represent these future benefits. (e.g. Ohlson and Gao 2006, Christensen and Feltham 2009,

Penman 2012). Yet, the valuation purpose of accounting does not imply that all items that

represent any kind of future benefit (or any kind of obligation) should be shown on the balance

sheet due to the qualitative and enhancing characteristics of accounting information including

relevance, faithful representation and verifiability. The asset or liability being controlled by the

firm and being the result of a firm’s past event ensures verifiability of an asset’s or liability’s

existence. This aspect provides an upper bound to the definitions, that an asset or liability must

have economic substance, i.e., that they directly contribute to firm value. Little rigorous

academic research provides empirical evidence on the definition of the elements.

Uncertainty

Preliminary Views: The DP preliminary views are that the Conceptual Framework should not

set a probability threshold for the rare cases in which it is uncertain whether an asset or a liability

exists and the recognition criteria should not retain the existing reference to probability.

However, if there could be significant uncertainty about whether a particular type of asset or

liability exists, the IASB would decide how to deal with that uncertainty when it develops or

revises a Standard on that type of asset or liability.

Response (Question 3): How uncertainty should be viewed in identifying and reporting assets

and liabilities is an important issue on which Committee members expressed two different views.

Both views, though, seek some additional guidance beyond what is currently in the Preliminary

Views. Having the differing views suggests that this is an area that the Board should further

consider. We discuss these two views below.

One view expressed is that uncertainty about the existence of an asset or a liability could be

excluded from the recognition problem and exclusively be dealt with in the measurement.

Uncertainty about the existence of an asset or a liability implies that there is some probability of

the asset’s or the liability’s value being zero. Theoretically, the valuation of an asset or a

liability could incorporate these probabilities. A natural question is whether there could be some

adverse effect from including assets and liabilities on the balance sheet when the probability of

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their value being zero is above some threshold. There is some threshold where the lack of

evidence on an asset’s or a liability’s true value (and, in the end, its very existence) creates noise

that has the potential to dampen the informativeness of the firm’s earnings and relevance of

financial information. This threshold apparently needs to vary with the type of asset or liability.

If the situation in which the value of the asset or liability is specified in a contract or a similar

arrangement (for example, in the case of financial derivatives such as option contracts), the asset

or liability can be verifiably included in the financial statement. If the risk of an asset or a

liability having a value of zero, however, arises from uncertainty about future states of nature

that are not clearly defined in a contract (for example, uncertainty about future regulation),

verifiability of the asset’s or liability’s existence is a greater issue. Identifying all assets and

liabilities, regardless of their magnitude, also triggers cost-benefit considerations.

The preliminary view, in line with extant IAS 37, suggests that uncertainty about an asset’s or a

liability’s existence is rare; the statement implies that cases in which measurement cannot

reliably deal with uncertainty were rare. We are not aware of any rigorous evidence on this

question. However, we caution that the lack of a principle on this matter could result in

inconsistent application across standards and, thus, ultimately in a lack of comparability (e.g.,

Benston, Bromwich and Wagenhofer 2006, Wüstemann and Wüstemann 2010).

Overall, theis view agrees that the recognition criterion should not retain the existing reference

to probability but only to the extent that there are other criteria that ensure a minimum level of

verifiability of recognized assets and liabilities (see our response to Question 2 above where we

address “control” and “past events”). For example, an option is an extreme case. With an

option, even if there is only a remote possibility of a positive cash flow, the existence of a

contract that exactly specifies the details of the contingency and advanced valuation techniques

in option pricing ensure some minimum level of verifiability. Many other assets or liabilities will

lack this feature.1

A second view expressed is that there if there is uncertainty about the existence of an asset or a

liability, then there needs to be some threshold for recognition. Without a threshold, assets and

liabilities that exist could potentially be excluded (i.e., all that are not absolutely certain to exist),

or include assets and liabilities for which it is unlikely they exist. Neither outcome would seem

to be helpful to users of financial statements.

Constructive Obligation

Preliminary Views: For constructive obligations, the DP’s preliminary view is that the existing

definition of a liability—which encompasses both legal and constructive obligations—should be

retained and more guidance should be added to help to distinguish constructive obligations from

economic compulsion.

1 Following the qualitative characteristics in Chapter 3 of the existing Conceptual Framework, the principle of

faithful representation implies the neutral presentation of transactions, e.g., no systematic differences between the

recognition of gains and losses (or, more broadly, good news and bad news). Therefore, we do not require

systematically different levels of verifiability for assets and liabilities in our response. We note, however, that this

principle is controversially discussed in the accounting literature. At least some evidence and some theory indicates

that the asymmetric recognition of gains and losses (conditional conservatism) is enhancing the usefulness of

financial accounting numbers for contracting purposes (Watts 2003a, 2003b, Göx and Wagenhofer 2009).

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Response (Questions 5 and 6): Enforceability is an important means of verifying the existence

of a liability. However, it is not the only criterion by which verifiability can be ensured.

Constructive obligations can have substantial economic substance and a failure to report these

items could result in misjudgments unless, at the same time, the IASB developed an easily

accessible reporting mechanism for these kinds of obligations. Additionally, conditional

obligations can have considerable economic substance and, therefore, should not per se be

excluded from recognition. Thus, we support the IASB’s rejection of View (1) in Question 6.

The recognition of liabilities that are conditional on the firm’s own actions still bears the risk of

managers discretionarily managing earnings through real activities. So there should be a higher

threshold for the recognition of conditional liabilities. It is unclear whether a firm’s practical

ability is a useful distinction. The examples in Table 3.2 show that the interpretation of

‘practical ability’ is vague and that there is room for substantial discretion. In addition,

‘practically unconditional’ may be similar to the notion of economic compulsion, which the

IASB rejected in its tentative views on constructive obligations. It is also important to note that

by rejecting View 1, the Board will need to consider the implications for other areas such as

IFRIC 21, Levies.

If View (2) in Question 6 is incorporated in the Conceptual Framework , the Framework should

also include more guidance on the definition of a firm’s practical ability to avoid future actions.

If View (3) is kept in the Framework, it should be accompanied by emphasis on additional

requirements in individual standards that restrict the opportunistic recognition of those

conditional liabilities.

Finally, it is unclear whether there is a difference between a constructive obligation and

economic compulsion. The DP seems to imply that these are different. However, economic

compulsion would seem to put the company in a position where it has no alternative but to

satisfy the claim.

Related Academic Literature and Discussion: Academic research supports the view that

financial statement users consider constructive obligations to be liabilities. Research has found

that certain constructive obligations that may be considered constructive obligations in some

settings are related to firm value and cost of capital. For example, studies find that pension

obligations and post-retirement obligations, that had been reported “off-balance sheet” prior to

being recognized (Landsman 1986; Amir 1993; Mittelstaedt and Warshawsky 1993), were

related to firm value prior to being recognized. Off-balance sheet operating leases have been

shown to be related to cost of capital in similar ways as financial leases (Bratten Choudhary

Schipper 2013).

However, Botosan et al. (2005) found that academic research had produced little evidence thus

far on how investors define an obligating event by which a legal or constructive obligation is

established. Based on our reading of the literature, we agree and we conclude that this question

still remains up for future research.

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Section 4 Recognition and Derecognition

Preliminary Views. The DP’s preliminary view on recognition is that an entity should

recognize all its assets and liabilities, unless the IASB decides when developing or revising a

particular Standard that an entity need not, or should not, recognize an asset or a liability because

it would not be relevant, or no measure of the asset (or the liability) would result in a faithful

representation.

Response (Questions 8 and 9). In general, we agree that the Conceptual Framework should

state that all assets and liabilities should be recognized in the financial statements if they meet

the definition of an asset or liability. If the Board believes that an asset or liability should not be

recognized in the case of a specific standard, the Board should explain why.

Related Academic Literature and Discussion. Academic research most closely related to the

question of recognition (and derecognition) examines whether differences exist in how capital

market participants use information that is recognized versus disclosed. Overall, research

suggests that differences exist in how capital market participants view recognized versus

disclosed information. Differences in processing of recognized and disclosed amounts have been

attributed to various reasons including processing costs of footnote disclosures (Barth et al.

2003), reliability or quality of information (Choudhary 2011), and behavioral biases (Hirshleifer

and Teoh, 2003). However, academic research has limited direct evidence on the relevance of

recognized versus disclosed items. Research on whether an item is a faithful representation is

also scarce.

To examine relevance, accounting research generally relies on some valuation model that

examines the association between market value (or changes in market value) and measures of the

book value of equity and/or earnings. In the context of recognition versus disclosure of an

unrecognized item, the measures of the book value and earnings can be based on disclosed

amounts or estimated amounts that would be reported. If the accounting measure is significantly

associated with the market valuation, then the measure is considered relevant regardless of

whether it is recognized or disclosed. Different weighing of the recognized versus disclosed

amounts could indicate differences in relevance. Schipper (2007) observes that there are at least

three major views on whether and how capital market participants use recognized versus

disclosed amounts:

1. a ‘‘no differences’’ view that suggests all financial reporting information is used in the

same way regardless of where it is reported;

2. a ‘‘rational differences’’ view that suggests that recognized and disclosed items differ in

information features such as reliability that affect decision usefulness;2

2 Much of the academic accounting literature examines the qualitative characteristics of reliability rather than a

faithful representation. In part, this difference is due to reliability being a qualitative characteristic of accounting

information before the revised Conceptual Framework (IASB 2010). In this discussion, we will refer to reliability

similar to Bratten et al (2013) who view reliability as a construct that subsumes “the constructs represented by

‘verifiability’ and ‘representational faithfulness’ in Statement of Accounting Concepts No. 8 (FASB 2010b), where

faithful representation means that a depiction is complete, neutral, and free from error. Freedom from error refers to

the inputs and process used to produce reported information. Verifiability means that different knowledgeable and

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3. a ‘‘user characteristics’’ view that suggests that cognitive factors including biases induce

differences in how disclosed and recognized items are used.

Academic research identifies differences in how capital market participants use recognized

versus disclosed items (e.g., Ahmed et al. 2006; Davis-Friday et al. 1999). Therefore, the “no

differences” view is not descriptive nor is it conclusive as to why differences exist. For example,

Davis-Friday et al. (2004) investigates other post-retirement benefit disclosures, required by the

Securities and Exchange Commissions Staff Accounting Bulletin 74 prior to recognition under

SFAS 106 (FASB 1990) in the U.S. They find lower valuation weights on the required

disclosures compared to the recognized amounts, implying the disclosures are less reliable than

the recognized amounts. Similarly, Ahmed et al. (2006) investigate differences in the value

relevance of the disclosed versus recognized fair value of derivatives held by bank holding

companies in the context of SFAS 133. Prior to SFAS 133, the fair values of some derivatives

were disclosed. After the adoption of SFAS 133, fair values were recognized. Ahmed et al.

(2006) find that recognized fair values of derivatives are related to market values, but disclosed

fair values of derivatives are not.

Finding differences between the disclosed and recognized amounts could be due to information

features of the disclosed information (“rational differences”) or the cognitive factors in

processing the information (“user characteristics”). For example, the post-retirement benefit

disclosed data that Davis-Friday et al. (2004) examine included range estimates while the

recognized amount is a point estimate. Therefore, the reliability of the disclosed data may differ

and / or processing costs could differ. Ahmed et al. (2006) view their results as consistent with

costly processing and/or limited investor attention (a type of cognitive bias).

In a related study, Michels (2013) finds that market prices are more sensitive to natural disasters

that occur before a firm’s reporting date (i.e., that affect recognized accounting numbers) than to

those that occur subsequent to the reporting date (i.e., the effects of which are only disclosed in

the footnotes). The evidence points to greater expertise and higher search costs needed for

processing footnote disclosures.

When the information features between recognized and disclosed amounts are similar (no

“rational differences”), financial statement users could perceive the recognized and disclosed

information more similarly. Bratten et al. (2013) use disclosures of operating and capital

(finance) leases to estimate the amounts that would be recognized if all operating leases were

capitalized. They determine that the estimates of operating leases are associated in similar ways

to proxies for costs of debt and equity (another measure of relevant information) as the

recognized capital leases. By comparing disclosed operating leases to the recognized capital

(finance) leases as a firm-specific check, they mitigate differences in the reliability of the

disclosed versus recognized lease information. In further analysis they find that when operating

lease disclosure is less reliable, the association with the proxies for the cost of debt and equity

are also lower.

independent observers would reach consensus.” Under IFRS terms ‘reliability’ is encapsulated by ‘faithful

representation’ (See discussion in basis for conclusions IASB 2010 CF par BC3.20 – 3.25)

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When the user characteristics are considered (“user characteristics”) and the reliability of the

disclosed information is considered high (no “rational differences”), financial statement users

could perceive the recognized and disclosed information more similarly based on the

characteristics of the users. For example, Yu (2013) examines whether pension liabilities that

were disclosed under SFAS 87 and subsequently recognized under SFAS 158 in the U.S. are

valued similarly. Yu (2013) finds that that off-balance sheet pension liabilities under SFAS 87

are more value relevant for firms with higher levels of institutional ownership or analyst

following. After the liabilities are recognized on the balance sheet, he finds less of a difference

in valuation based on institutional ownership and analysts following, implying that user

characteristics are associated with the lack of relevance or less relevant disclosed information.

We do not address whether and how the IASB should consider specific user characteristics.

Rather, we observe that in an information rich environment with owners who act as active

monitors and intermediaries who analyze and disseminate information about firm value, the

value relevance of disclosed versus recognized information can differ depending on the expertise

of the users of the financial statements.

In the discussion of recognition versus disclosure, we also note that academic research has

emphasized the need for verifiability, an enhancing qualitative characteristic, and verifiability

thresholds. This literature typically takes a contracting perspective emphasizing the needs of

lenders and debt holders (e.g., Kothari et al. 2011). For example, non-verifiability creates

incentive problems between shareholders and debt holders that require firms to contract outside

of the financial statements (Nikolaev 2010) . For example, non-verifiability creates incentive

problems in evaluation of managerial performance in contracts between shareholders and

managers (Lambert 2010). The concern of verifiability is also discussed in the context of

accounting conservatism, where conservatism is defined as “the accountant’s tendency to require

a higher degree of verification to recognize good news as gains than to recognize bad news as

losses,” a definition that is consistent with the adage “anticipate no profits but anticipate all

losses.” (Basu 1997, p. 7). A differing threshold for recognizing good news versus bad news

introduces bias into financial reporting , which is inconsistent with the neutrality characteristic

of faithfully represented information.

Section 5 Definition of Equity and Distinction between Liabilities and Equity Instruments

Definition of Equity

Preliminary Views. The DP’s preliminary views are that the Conceptual Framework should

retain the existing definition of equity as the residual interest in the assets of the entity after

deducting all its liabilities, and the Conceptual Framework should state that the IASB should use

the definition of a liability to distinguish liabilities from equity instruments.

Response (Question 10): We agree that the Conceptual Framework should retain the existing

definition of equity as the residual interest in the assets of the entity after deducting all its

liabilities. The distinction between liabilities and equity has been difficult to apply and has been

an ongoing discussion of standard setters. Yet, at the conceptual level, equity is the residual

claim of the owners. As such, it is most feasible to define equity as the remainder after defining

assets and liabilities.

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The existing definition of equity is based on the strict obligation approach, not the narrow equity

approach. The latter approach is not consistent with the approach taken in standard setting either

in IAS 32 or in U.S. GAAP. Therefore, if the IASB would proceed on this basis, it should

consider adding a reconsideration of IAS 32, Financial Instruments: Presentation, to its agenda

shortly after completion of this project.

Updating the measure of each class of equity claim at the end of each period is an event that can

trigger a capital gain or loss. If the event of change in fair value is regarded as a trigger, the

entity should update the measure of equity, and this method is consistent with IFRS 9. As the

information about priorities and payment requirements of existing claims and income attributable

to each equity affects information users’ decision making, we support recognizing any update to

those measures in the statement of changes in equity as a transfer of wealth between classes of

equity claim. However, under this proposal, a reduction in the fair value of a liability can also be

seen as a transfer of wealth between creditor and equity shareholder (e.g. Barth and Landsman

1995).

Entity with No Equity Instruments

Preliminary View: The DP proposes that if an entity has issued no equity instruments, it may

be appropriate to treat the most subordinated class of instruments as if it were an equity claim,

with suitable disclosure.

Response. We agree with this view. For example, the view can be applied to co-operative

entities and is broadly consistent with IAS 32. However, in International Co-operative Alliance

Principles (ICA 1995), principle 2 “Democratic Member Control” and principle 3 “Member

Economic Participation” deny the characteristics of capital of profit sharing and control. The

refundable characteristic of co-operative entities’ capital is derived from unity and adhesion of

its capital and members. The capital of co-operative entities is different from the equity of profit-

oriented firms. If fair value measurement is required for refunding capital or if the dividend

distribution of the capital become de rigueur, it might cause other problems whether this

treatment is suitable or not for co-operative entities. We believe that the IASB should consider

the approach applicable entities such as co-operative and privately-held firms separately from the

approach for the general purpose financial statements applicable to public, profit-oriented

entities.

Related Literature and Discussion. The DP discusses that a specific consequence of using the

definition of a liability to distinguish liabilities from equity instruments, namely that obligations

to issue equity instruments are not liabilities. While little academic literature specifically

examines the classification of an item as a liability or equity, a recent study by Barth Hodder and

Stubben (2013) address whether employee stock options share more key characteristics with

liabilities or equity.3 Using common equity as the benchmark claim for equity and straight debt

as the benchmark claim for liabilities, they explore the relation between employee stock options,

common equity risk and expected return. They find that the extent to which a firm has

3 The Committee continues to examine related academic research in this area to further inform in the review of the

Conceptual Framework. We will submit findings to the Board at a later date.

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outstanding employee stock options is negatively associated with common equity risk and

expected return, which is opposite the association of liabilities and implies employee stock

options are similar to equity. They explore a number of additional tests to confirm this finding

and conclude that employee stock options share more characteristics with equity than debt,

implying that they should be classified as equity. Their finding is, thus, consistent with the

views in the DP.

Standard setters have been trying to resolve the distinction between liabilities and equity

instruments for at least twenty years. Below we discuss some of the theoretical issues raised in

the discussions. We also refer the Board to AAA FRPC (2009) and the AAA FASC (2001,

1999, 1993) for academic commentaries on these standard setting issues on the distinction

between liabilities and equity.

Section 6 Measurement

Preliminary Views. The DPs preliminary view is that the objective of measurement is to

contribute to the faithful representation of relevant information about the resources of the entity,

claims against the entity and changes in resources and claims; and how efficiently and effectively

the entity’s management and governing board have discharged their responsibilities to use the

entity’s resources. The DP states that a single measurement basis for all assets and liabilities

may not provide the most relevant information for users of financial statements.

Further, when selecting the measurement to use for a particular item, the IASB should consider

what information that measurement will produce in both the statement of financial position and

the statement(s) of profit or loss and OCI.

The DP states that the relevance of a particular measurement will depend on how investors,

creditors and other lenders are likely to assess how an asset or a liability of that type will

contribute to future cash flows. Consequently, the selection of a measurement for a particular

asset should depend on how that asset contributes to future cash flows; and for a particular

liability should depend on how the entity will settle or fulfill that liability. Additionally, the

preliminary views are that the number of different measurements used should be the smallest

number necessary to provide relevant information and the benefits of a particular measurement

be sufficient to justify the cost.

The DP’s preliminary views on subsequent measurement of assets are based on how the asset

contributes to future cash flows and whether the asset is a financial asset. The DP’s preliminary

views on the subsequent measurements of liabilities are based on whether the liability will be

transferred or settled.

Response (Questions 11 to 14). In general, we agree with the stated objective of measurement,

that a single measurement basis may not provide the most relevant information, that the IASB

should consider the information in all financial statements, and that the benefits of a particular

measurement should be sufficient to justify the costs (Question 11 (a), (b) , (c) and (f)). These

parts are consistent with the objective of general purpose financial reporting and qualitative

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characteristics in the current Conceptual Framework. While keeping the number of different

measurement bases to a minimum is a desirable feature, we do not consider it a primary goal

(Question 11 (e)). The selection of a measurement basis should be based on the objective of

financial reporting and qualitative characteristics.

The IASB’s preliminary view, that the relevance of a particular measurement depends on how

investors, creditors and other lenders are likely to assess how an asset or a liability will

contribute to future cash flows, merits additional consideration (Question 11 (e), 12 to 14). The

DP gives consideration to the qualitative characteristics and enhancing characteristics in

determining the measurement basis. This focus on future cash flows appears to emphasize the

predictive value aspect of relevance. Information is not necessarily relevant when it has the

attribute of predicting itself (Barth 2007, FN 10).4 Academic research cited below shows that

fair values help predict future cash flows. However, current fair values or changes in them do

not necessarily predict future fair values or changes in them, and need not do so to have

predictive value to be useful to financial statement users (Barth 2007, FN 10).

Further, as noted in the DP, it is well established in economic theory that firm value is the

discounted sum of its future cash flows.5 Each asset and liability, then, can be also measured at

the present value of its future cash flows. Based on this, the value of an asset or liability, is the

sum of the present value of its future cash flows regardless of how it is being used. That is,

economic theory does not address how the individual asset or liability contributes to future cash

flows.

As inventory id held for sale, there is also a question on the consistency of accounting for

inventory using a cost-based measure. Current market-based measures are being considered for

other assets held for sale. While discussed in ¶6.80 and 6.81, the arguments for the exclusion of

inventory are not internally consistent. Excluding inventory, which is held for sale, seems to be

an exception that does not exist at the conceptual level.

Additionally, the DP does not allow for the revaluation of non-financial assets, such as long-

lived tangible and intangible assets, currently allowed under IFRS. As discussed below,

academic research finds that long-lived asset revaluations are related to firm value and

informative to financial statement users.

Related Academic Research and Discussion. A stream of academic research examines the

informativeness of fair values by examining the association between fair values and future firm

performance, fair values and market values, and fair values and other relevant firm

4 For example, cost-based depreciation is persistent, i.e. it has the ability to predict future values of itself. However,

cost-based depreciation may not necessarily be predictive of future cash flows. 5 This idea is not new: in the late 1930s, Coase (1937) explained his theory of what a firm is by pointing out why

firms exist in a modern market economy. His theory is that a cost saving can be achieved by organising activities via

a firm, as opposed to all transactions taking place through the market. In his opinion, two costs that could be saved

on are the cost of discovering what the market prices are (which suggests that market prices are not always easily

obtainable) and that of negotiating a contract for each exchange transaction. Hence, firms exist because markets are

imperfect and market prices do not measure value under every condition (Penman, 2007). In some cases, firms and

their structures are more efficient than markets. Entrepreneurs exploit these efficiencies, while historical cost

accounting reports on how well firms deal with imperfect market prices (Penman, 2007).

13

characteristics.6 Academic research has investigated fair values of financial assets, non-financial

assets, and liabilities. As noted in Barth (2007), academic research supports the view that fair

values are a valid measurement basis that is consistent with fundamental and enhancing

qualitative characteristics of the Conceptual Framework. That is, fair values are relevant,

faithfully represent economic phenomena, and enhances comparability within and across firms.

A key consideration in the DP relating to the subsequent measurement of assets and liabilities

appears to be how the asset contributes to future cash flows. Academic research has studied the

ability of asset revaluations to contribute to future cash flows in varying contexts. For example,

upward revaluations of long-lived assets are associated with future firm performance and cash

flows (Aboody et al. 1999). Academic research, however, has not specifically addressed how --

whether directly or indirectly -- an asset or liability contributes to future cash flows.

Empirical academic research also finds that fair value measurements of financial and non-

financial assets are related to firm value. For tangible long-lived assets, academic research

shows that fair value revaluations are related to firm market values (Muller and Riedl 2002;

Gordon 2001; Aboody et al. 1999; Easton at al. 1993). These studies typically examine the

association between the revalued amount, or the increment between historical cost and the

revalued amount, and firm market prices or returns. Studies have found that revalued amounts

are significantly related to market measures and usually increase the ability of accounting

information to explain market prices. In contrast, Barth and Clinch (1998) do not find asset

revaluations of long-lived tangible assets are related to firm value but those of intangibles assets

are. While the DP does not propose to allow fair value reporting for long-lived assets, research

indicates that these amounts are relevant and faithfully represent economic transactions and

events.

Research on financial assets such as investment securities indicates that fair values are associated

with market values and returns whether disclosed or reported and regardless of management

intent. For example, Park et al. (1999) investigate fair value measures by security type under

SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” in banks.

They find that fair values are related to firm value for available-for-sale (AFS) and held-to-

maturity (HTM) securities, implying that fair values provide information to financial statement

users, regardless of management intent in holding the security and whether fair values are

reported (for AFS) versus disclosed for (HTM). Badertscher et al. (2011) also use U.S.

companies and provide evidence that the market incrementally values “other-than-temporary

impairments” reported in net income on AFS or HTM securities. Bischof et al. (2011)

investigate banks reporting under IFRS and offer similar conclusions on the informativeness of

fair values. Khurana and Kim (2003) find that fair values and historical costs are equally

informative in bank-holding companies. Additionally, several studies find evidence of the

informativeness for market prices and returns of fair values of certain banks assets and liabilities

6 Several studies discuss the use of fair value accounting and the 2008 financial crises. The overall conclusion of

these studies is that the use of true fair value measures was not very widespread before the crisis and that it is, thus,

highly unlikely that fair value played any causal role in the financial crisis (i.e. Barth and Landsman, 2010; Laux

and Leuz 2010, 2009). While informative about the specific context, we do not review these studies for a discussion

about measurement in the conceptual framework.

14

disclosed under SFAS No. 107, “Disclosures about Fair Value of Financial Instruments” (Nelson

1996, Eccher et al. 1996, Barth et al. 1996, Barth 1994).

Several studies examine the association between a measures of a bank’s risk and fair value

measures of financial instruments, with findings suggesting fair values are more strongly

associated with risk than are historical cost measures. For example, Hodder et al. (2006) show

that the volatility of income incorporating fair values is more strongly associated with certain

measures of firm risk than is the volatility of historical cost US GAAP-based measures.

Blankespoor et al. (2012) find that leverage measured using the fair values of financial

instruments explains significantly more variation in certain credit risk measures than leverage

using fewer fair value measures.

We should note that informativeness has been found to vary with certain characteristics of the

firm and with the source of the fair value estimates. For example, studies examine whether the

informativeness of fair values is associated with the source of the fair value estimate. Muller and

Riedl (2002) provide evidence that fair value estimates of investment properties by appraisers are

more relevant than those made by managers. In contrast, Barth and Clinch (1998) find that the

source of the fair value for long-lived asset revaluations (management or external appraisers)

does not matter. Research also investigates whether the source of the inputs into the fair value

estimates is associated with the informativeness of fair values. Research on fair value of

mortgage servicing rights indicates that fair values based on market inputs (Level 2) as well as

managerial inputs (Level 3) are informative (Altamuro and Zhang 2013). Somewhat in contrast,

Chang Joon et al. (2010) examine the fair value hierarchy information in quarterly reports of

banking firms reported under SFAS No. 157 (FAS No. 157), “Fair Value Measurements,”

finding that the value relevance of Level 1 and Level 2 fair values is greater than the value

relevance of Level 3 fair values, implying those fair value estimates that require more managerial

inputs are less relevant. However, when corporate governance is stronger, the Level 3 fair values

become more relevant. Related, a firm’s information environment can also be a factor in the

informativeness of fair value. While Khurana and Myung-Sun (2003) find that fair values and

historical costs are equally informative in bank-holding companies, their results do not hold for

small bank holding companies in information poor environments (not followed by analysts).

The overall conclusion from the research reviewed is that fair value information benefits

financial statement users. See Barth (2007), Barth and Landsman (1995) and Landsman (2007),

Landsman (2006) and Barth (2007), and Gebhardt (2012) for summaries of empirical research

relating to fair value measurement. We also refer you to Barth (2014) for a discussion of the

issue of measurement based on the qualitative characteristics of the Conceptual Framework.

The academic literature has expressed concern over the effect of a mixed measurement approach

on the usefulness of earnings. Since most fair value changes are reflected in profit or loss, one

consequence of this shift is that earnings is arguably measured closer to “economic income”.

However, economic income introduces transitory elements that exhibit low persistence into

earnings (Dichev, 2008; Dichev and Tang, 2008). In this regard, Schipper and Vincent (2003:

99) argue that persistence is a desirable earnings quality attribute, because a particular realization

from a persistent earnings series “is a more readily usable shortcut to valuation by, for example,

a price-to-earnings multiple”. Hence, the presence of transitory income components makes

15

current accounting earnings a poor proxy for future expected earnings (Ohlson, 1999; Van

Cauwenberge and De Beelde, 2007).

The main concern with aggregate earnings determined in accordance with a mixed measurement

approach is that such aggregate earnings includes non-recurring items which obscure the

valuation properties of earnings. Dichev and Tang (2008) document a deterioration of all key

properties of earnings, including persistence and volatility, over 40 years. They attribute their

findings to the fact that standard setters have moved away from matching to fair value

accounting.

We therefore believe that it is appropriate for the IASB to consider the effect of measurement on

both the statement of financial position and the statement of comprehensive income. In this

regard, we believe that the mixed measurement outcome reflected in earnings should be

addressed through the presentation and/or disclosure of remeasurements, as we advocate in

Section 8.

Section 7 Presentation and disclosure

At the onset of this section we would like to recognize the previous work of the IASB and the

FASB in the 2008 Discussion Paper on Financial Statement Presentation. This document

established three objectives of financial statement presentation (cohesiveness, disaggregation and

liquidity and financial flexibility) and related principles from the overall objective of financial

reporting. In our view, the Conceptual Framework would benefit from a greater emphasis on

these objectives and principles of financial statement presentation. The existing Conceptual

Framework does not present guidance on presentation or disclosure.

The Board discusses five aspects of presentation related to the primary financial statements: what

the primary financial statements are; the objective of primary financial statements; classification

and aggregation; offsetting; and the relationship between primary financial statements. The

related questions for respondents are 16(a)(i) – (v).We discuss each topic in turn.

Identifying Primary Financial Statements (Question 16(a)(i))

Preliminary View. The Discussion Paper (¶7.14) presents the preliminary view that the

primary financial statements are “a) the statement of financial position, b) the statement of profit

or loss and OCI (or the statement of profit or loss and the statement of comprehensive income),

c) the statement of changes in equity, and d) the statement of cash flows.”

Response. We agree that the statement of financial position, the statement of changes in

equity, and the statement of cash flows are all primary financial statements. However, we believe

that all items of income and expense (i.e., all non-owner changes in shareholders’ equity) should

be presented in a single statement of comprehensive income.

Related Academic Literature and Discussion. A number of research studies related to this

issue were conducted when the debate centered on whether to report items of OCI directly in

shareholders’ equity or in a performance statement. As a result, the findings of these studies

should be interpreted in this context. For example, Hirst and Hopkins (1998) present

16

experimental evidence that analysts are better able to adjust company valuations for earnings

management when net income and OCI are presented on the same page. Thus, they provide

evidence in support of contiguous (i.e., same page) reporting for net income and OCI. However,

they do not explicitly compare the option of a single performance statement title versus two

performance statement titles.

Hunton et al. (2006) present experimental evidence that financial executives are less likely to

manage earnings through selective sale of securities when OCI is reported in a single statement

of comprehensive income. Although Hunton et al. (2006) do use a single statement, they

compare the reporting of items in OCI between the statement of changes in equity and a single

performance statement. They do not include the option of two performance statements in their

empirical design.

Lee et al. (2006) show that property-liability insurers that smooth earnings by “cherry-picking”

realized gains and losses on certain marketable securities are less likely to report comprehensive

income in a performance statement. Included in their sample are 29 companies with separate

statements of comprehensive income and 13 companies with a combined statement (out of a total

of 82 companies), but they do not conduct separate tests for these groups. Chambers et al. (2007)

also aggregate companies reporting OCI in a single performance statement with those reporting

in two performance statements. They find that less than 20% of the firms in their sample report

OCI in a single performance statement, and the association of certain components of OCI with

stock returns for these companies is not value relevant. Chambers et al. (2007) suggest that this

finding may result from low power; they note that “it is difficult to imagine reporting location

affecting the pricing of one component of OCI and not another” (p. 589).

Bamber et al. (2010) present evidence that firms that make use of the choice within accounting

standards to present comprehensive income in equity and not in a performance statement are

headed by CEOs with strong equity incentives and less job security. Although Bamber et al.’s

(2010) primary analysis combines companies reporting OCI in a single performance statement

with those reporting in two separate performance statements, they also find evidence consistent

with the idea that companies reporting in a single statement are distinct from those reporting in

two separate performance statements (see pp. 120-121).

We conclude that research to date provides support for the usefulness of reporting OCI in a

single performance statement of comprehensive income. However, we also believe that more

research explicitly addressing whether it is more useful to use one or two performance statements

could inform the debate.

Objective of Primary Financial Statements (Question 16(a)(ii))

Preliminary View. The DP (¶7.17) presents the preliminary view that the objective of the

primary financial statements is to provide “summarized, information about recognized assets,

liabilities, equity, income, expenses, changes in equity and cash flows that has been classified

and aggregated in a manner that is useful to users of financial statements in making decisions

about providing resources to the entity.” In (¶7.18) it is further stated that this summarized

information is intended to provide information about financial position (¶7.18(a)), financial

performance (¶7.18(b)), and how efficiently and effectively management has discharged its

responsibility to use the entity’s resources (¶7.18(c)). It is also stated in ¶7.19 that users must

consider information provided in the notes to the financial statements.

17

Response. We agree with the objective of primary financial statements stated in ¶7.17, as it

flows from the objective of financial reporting already established in the existing Conceptual

Framework.

Aggregation and Classification (Question 16(a)(iii)) Preliminary View. The DP (¶7.21) defines classification as the “sorting of items based on

shared qualities” and aggregation as “the adding together of individual items within those

classifications.” The IASB has expressed the preliminary view (¶7.26) that items should be

classified and aggregated into line items and subtotals if they are similar in function (e.g., selling

goods and services, manufacturing, etc.), similar in nature (e.g., wholesale and retail revenues,

fixed-income and equity investments), or similar in measurement attribute (e.g., cost and fair

value).

Response. This preliminary view lays out guidance how to classify and aggregate. Although

the negative consequences of inappropriate aggregation are pointed out, guidance is not provided

on the important issue of when to disaggregate items. The preliminary view, as written, could be

interpreted to imply that items should be disaggregated only if they are dissimilar in function,

dissimilar in nature, and dissimilar in measurement attribute. Further, disaggregation decisions

appear to be left to the entity, with an option for intervention of the IASB for particular items.

We believe that providing additional guidance on how to make disaggregation choices is of

critical importance for the revised Conceptual Framework.

Related Academic Literature and Discussion. A number of research studies have found

evidence of the usefulness of disaggregating components of income based on particular

principles such as value relevance, persistence, and predictive value (see e.g., Lipe 1986;

Fairfield et al. 1996; Sloan 1996; Barth et al. 1999; Ohlson 1999; Barth et al. 2001b; Burgstahler

et al. 2002; Dechow and Ge 2006; Cready et al. 2010; Jones and Smith 2011; Venter et al. 2013;

Libby and Brown 2013). These characteristics are also closely related to concepts in the

Conceptual Framework.

Persistence is a measure of earnings sustainability or recurrence (Francis et al., 2004), and refers

to the ability of earnings (or components) to predict future values of itself (or themselves) (Lipe,

1986; Kormendi and Lipe, 1987). As part of its financial statement presentation project, the

IASB and FASB proposed that comprehensive income be disaggregated on the basis of

persistence and measurement subjectivity, because “those appear to be the primary factors that

users take into account when predicting future cash flows” (IASB, 2008).7

Predictive value refers to the ability of earnings (or components) to be useful in a forecasting

process (Fairfield et al., 1996). The IASB identifies predictive value as an attribute of relevance.

It is important to understand the differences and similarities between persistence and predictive

value. As mentioned above, persistence is the ability of an item to predict itself, whereas

predictive value is the ability of an item to predict something relevant to the users of financial

statements (such as future earnings or cash flows). Therefore, a persistent item may also have

predictive value if the item has an impact on the future construct that is being predicted. For

7 The IASB and FASB also recognized the inter-relatedness of persistence and measurement subjectivity, because an

increase in measurement subjectivity often results in a decrease in persistence.

18

example, sales may have high persistence and predictive value for future cash flows, whereas

depreciation may have high persistence, but low predictive value for future cash flows. Both

persistence and predictive value also feature strongly in Section 8 of the DP.

An accounting amount is considered value relevant if it has a predicted association with share

prices or share returns (Barth, et al., 2001). Value relevance research uses accepted valuation

models to jointly assess the relevance and reliability (faithful representation) of accounting

amounts for equity investors who want to value a firm’s equity (Barth et al., 2001).8 This

approach assumes that it is an important function of accounting figures to reflect “economic

income”, as represented by share returns, and economic value, as reflected by share prices

(Hellström, 2006).9

The basic conclusion of the research in this area is that disaggregating components of earnings

with differing characteristics such as value relevance, persistence, and predictive value is useful

to investors and creditors. For example, Lipe (1986) found a stronger market reaction in U.S.

companies to components of earnings which exhibit greater persistence. Fairfield et al. (1996)

found that forecasts of future return on equity for U.S. companies improved when they were

based on components of earnings disaggregated by function. Tarca et al. (2008) presents

experimental evidence that disaggregating earnings into “earnings before re-measurements” and

“re-measurements” improves the accuracy with which users extract financial information from

the income statement. Venter et al. (2013) find that mandatory disaggregation of certain earnings

components in South Africa helps investors price components of earnings consistent with their

persistence. Finally, Libby and Brown (2013) show that presenting disaggregated components of

earnings may increase the reliability of financial statements for U.S. companies. Additional

research related to disaggregation that focuses on OCI is presented in our discussion of Section 8

of the DP.

We recognize that determining the principles upon which to base disaggregation decisions is a

difficult challenge. For example, what if two items are similar in terms of predictive value, but

differ in persistence? Should there be a hierarchy of principles? Further, once a set of principles

for disaggregation is determined, should management make the decision on which items to

disaggregate? Or should a characteristic like persistence, for example, be used to create

mandatory disaggregation categories?

In spite of these difficulties, we believe that the IASB in their joint financial statement project on

financial statement presentation with the FASB had made progress in this regard by documenting

a disaggregation objective and related principles. We believe the Conceptual Framework would

benefit from the inclusion of these objectives and principles.

8 Relevance and reliability (faithful representation) are two key qualitative characteristics in the IASB Conceptual

Framework. 9 In the literature, economic income is often related to the concept of Hicksian income. Hicks (1946) refers to the

income of an individual, but his definition can be restated for a firm as “the maximum amount that could be

distributed to the equity shareholders in a period and leave intact the capital value of the company’s prospective

receipts as at the beginning of the period” (Bromwich, Macve and Sunder, 2010:351; Solomons, 1961).

19

We note that this section of the preliminary view explicitly addresses classification and

aggregation on the face of the financial statements. However, it is also important to note that

even if items are aggregated into one line on the financial statements, disaggregated information

can be provided in other ways. Options include presenting disaggregated information

parenthetically on the face of a financial statement (e.g., fair value measurements), in the notes to

the financial statements (e.g., pensions), and even in separate financial statements (e.g., OCI).

We will discuss these and related issues in later sections.

Offsetting (Question 16(a)(iv))

Preliminary View. The DP (¶7.29 – 7.30) defines offsetting as combining “dissimilar items

(assets/liabilities, income/expenses, cash receipts/cash payments, contributions to

equity/distributions of equity).” The IASB expresses the preliminary view that offsetting will

generally not provide the most useful information, but that they may choose offsetting when it

provides a more faithful representation, or for cost-benefit reasons.

Response. We agree with the view that offsetting does not provide the most useful

information. We agree that the IASB should require disclosure of the gross amounts of items that

are offset in the financial statements.

Relationship between Primary Financial Statements (Question 16(a)(v))

Preliminary View. The DP (¶7.31) presents the IASB’s preliminary view that no primary

financial statement has primacy, but should be looked at together. Further, they note that

financial statements are more informative to users if relationships between the statements and

among the line items are made clear.

Response. We agree with the IASB that all four primary financial statements should be

considered together. However, we would like to see the Board provide more definite guidance

about how the relationships among the statements and line items are to be made clear.

Specifically, we recommend the Board consider requiring that companies use the direct method

to prepare their cash flow statement, and provide reconciliations between line items on the

statement of comprehensive income and the cash flow statement.

Related Academic Literature and Discussion. There is a scarcity of literature on this topic. In

our view, the direct method of the cash flow statement provides a clearer link between the

statement of comprehensive income and the operating section of the cash flow statement than the

indirect method. Hales and Orpurt (2013) provide an overview of the academic literature on the

reporting of cash flows from operations. Their review highlights that the direct method

components of cash flow from operations contains incremental information to the indirect

method which enhances predictions of future cash flows and earnings. Stock returns of firms

disclosing direct method information contain more information about future performance than

firms which disclose only indirect method information. In addition, their review argues that

estimating direct method components from information prepared in terms of the indirect method

contains significant measurement error.

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Disclosure in the Notes to the Financial Statements

The Board discusses two aspects of disclosure in the notes to the financial statements: the

objective of the notes to the financial statements (¶ 7.33 – 7.34) and the scope of the notes to the

financial statements (¶ 7.35 – 7.42). The related questions for respondents are 16(b)(i) – (ii).We

discuss each in turn.

Objective of the Notes to the Financial Statements (Question 16(b)(i))

Preliminary View. The DP (¶7.33) presents the preliminary view that the objective of the

notes to the financial statements is “to supplement the primary financial statements by providing

additional useful information about (a) the assets, liabilities, equity, income, expenses, changes

in equity and cash flows of the entity, and, (b) how efficiently and effectively the entity’s

management and governing board have discharged their responsibilities to use the entity’s

resources.” Further, the Board defines useful information in ¶7.34 as information that helps users

understand the “amount, timing and uncertainty of an entity’s future net cash inflows” as well as

how disclosures “reflect actions taken by management to discharge their responsibilities to use

the entity’s assets” (e.g., by protecting the entity’s assets from unfavorable economic factors and

ensuring the entity is in compliance with applicable laws, regulations, and contractual

provisions).

Response. We believe that the definition of useful information in the context of the notes to the

financial statements should also be tied to the qualitative characteristics in Chapter 3 of the

current Conceptual Framework. Specifically, we believe that an important purpose of the notes

to the financial statements is to ensure that combined financial statements and notes reflect these

qualitative characteristics. Below we offer a revision of the first sentence of ¶34 for the Board’s

consideration:

“To be useful, the information provided in the notes to the financial statements should reflect the

qualitative characteristics of financial information in order to help users of financial statements

understand the amount, timing and uncertainty of an entity’s future net cash flows.”

Related Academic Literature and Discussion. Schipper (2007), in her discussion of required

disclosures, notes that standard setters lack a conceptual purpose for disclosures and that

decisions about disclosure requirements in specific standards are ad hoc.10

She hypothesizes that

this is due to the difficulty in defining a clear objective function for required disclosures, which

are “economy-level policy choices, affecting multiple firms that differ in terms of both economic

10

We note that much of the academic literature related to disclosure has focused on voluntary disclosure choices

made by companies (see e.g., Healy and Palepu, 2001) rather than required disclosures. Few studies have found

changes in company behavior resulting from required disclosures. One exception is Chuk (2013), who examines

whether entities alter their behavior in response to new financial statement disclosures. She shows that new

disclosures related to expected rates of return (ERR) on pension assets (in SFAS No. 132R) led entities with

upward-biased ERRs responded to the new standard by increasing asset allocations to equities and/or by reducing

ERRs. Her study is the first to document changes in company behavior resulting from changes in disclosure

requirements.

21

circumstances and contracting arrangements and parties” (p. 303). However, Schipper (2007)

notes that purposes for disclosures are implicit in specific standards. For example, three

(apparent) purposes of disclosure in the FASB’s standards on pensions and other postretirement

benefits (i.e., SFAS No. 132 and SFAS No. 132R) are: “disaggregation to aid in prediction;

display of estimates and assumptions to facilitate the assessment of measurement uncertainty;

provision of an alternative accounting treatment” (p. 305).

We cite the three examples above to illustrate their relation with the qualitative characteristics of

financial information. Specifically, we believe that the implicit purpose of “disaggregation to aid

in prediction” ensures that the financial statements and notes reflect the qualitative characteristic

of relevance (i.e., predictive value and confirmatory value). We believe that “displaying

estimates and assumptions to facilitate the assessment of measurement uncertainty” ensures that

the financial statements and notes reflect the qualitative characteristic of faithful representation.

We believe that “provision of an alternative accounting treatment” ensures that the financial

statements and notes reflect the qualitative characteristic of comparability.

Thus, we believe that it would be a worthwhile effort for the Board to examine the explicit and

implicit purposes embodied in existing standards to determine whether the Conceptual

Framework could benefit from a disclosure framework where the purpose of disclosure are

linked to the qualitative characteristics of financial information.

Scope of Notes to the Financial Statements (Question 16(b)(ii))

The DP presents the IASB’s preliminary views about disclosures they would normally require in

a general disclosure standard or in particular standards. They also address the disclosure of

forward-looking information, types of disclosures to include, and comparative information.

Disclosures Normally Required

Preliminary View. The preliminary view of disclosures that would normally be required in a

general disclosure standard or in particular standards (¶7.35) includes: a) information about the

reporting entity as a whole in order to understand the financial statements and the effectiveness

of manager’s stewardship, b) amounts recognized in the primary financial statements, including

changes in these amounts, for example, disaggregation of line items, roll-forwards and

reconciliations, c) the nature and extent of the entity’s unrecognized assets and liabilities, d) the

nature and extent of risks arising from (recognized or unrecognized) assets or liabilities, and e)

the methods, assumptions and judgments, and changes therein, that affect amounts presented or

disclosed. The Board does not intend for entities to provide information to the extent that users

can recalculate recognized amounts. Rather, the information should allow users to identify key

drivers of financial position and performance, and to understand key risks and key uncertainties

about measurements. However, the Board is clear that management’s views belong outside

financial statements (e.g., in management commentary).

Response. We believe this list could expand if the Board considers tying the disclosure

framework to the qualitative characteristics.

22

Forward-looking Information

Preliminary View. The DP presents the preliminary view (¶7.39) that forward-looking

information should only be required in the notes to the financial statements if it provides

“relevant information about assets and liabilities that existed at the end of the reporting period or

during the reporting period.” Relevant information is that needed to understand reported

measures (e.g., measures based on future cash flows) and to understand the sensitivity of those

measures to risk and to assumptions and judgments made during measurement.

Response. The term “forward-looking information” in this context may be misleading. The

financial statements and notes include forward-looking information in numerous areas (estimates

of useful lives, loan loss estimates, inventory reserve, cash flow projections for impairment

analysis, fair value estimates…). Therefore, we encourage the Board to further consider

different types of forward-looking information and then consider the appropriate placement.

Types of Disclosures in the Notes to the Financial Statements

Preliminary View. The DP presents a list of example disclosures the Board can consider (see

Table 7.1).

Response. We agree that this list provides good examples, but we believe these examples

could also be discussed in terms of how they reflect the qualitative characteristics of financial

information.

Comparative Information

Preliminary View. The DP presents the Board’s preliminary view that a complete set of

financial statements includes information about the preceding period, but additional comparative

information is permitted and sometimes required. The Board views this comparative information

as an integral part of the financial statements.

Response. We agree with this view as it is based on the qualitative characteristic of

comparability.

Materiality (Question 17)

Preliminary View. Paragraph 7.45 describes the IASB’s preliminary view that the concept of

materiality is clearly described in the existing Conceptual Framework. Consequently, the IASB

does not propose to amend, or add to, the guidance in the Conceptual Framework on materiality.

However, the IASB is considering developing additional guidance or education material on

materiality outside of the Conceptual Framework project.

Response. The IASB’s preliminary view is not to amend or add to the guidance of the

materiality guidance in the Conceptual Framework, because they view the manner in which the

concept is applied in practice as a “failure to use professional judgment”. However, a failure to

use professional judgment may also be the result of an imprecise description of the concept in the

Conceptual Framework. Given the inconsistencies in the application of the materiality concept

highlighted in the literature review below, we believe that the definition of materiality in the

23

Conceptual Framework can be improved. This could be achieved by aligning the materiality

definition more closely with the wording of the objective of financial reporting and the

qualitative characteristics in the Conceptual Framework. In particular, the materiality definition

could clarify that misstatements or omissions are material if they could influence existing and

potential investors, lenders and other creditors’ resource allocation decisions. This would make

the materiality definition clearer because it identifies from whose perspective materiality is

evaluated and which decisions are affected. It also implies that materiality should be considered

for both the presentation of information in the primary financial statements (line items, totals and

subtotals) and the disclosure in the notes.

The materiality definition could further clarify that any misstatements or omissions which

jeopardize the fundamental qualitative characteristics of relevance or faithful representation are

material. In addition, misstatements or omissions which jeopardize the enhancing qualitative

characteristics of comparability, verifiability, timeliness and understandability may be material.

For example, if an entity reclassifies a major expense in the income statement to a different line

item without restating the comparative figures, this may be considered material because it

impairs comparability of information.

Related Academic Literature and Discussion. Academic literature shows that the

materiality concept is not applied consistently in practice in a manner which the IASB may have

intended. For example, Libby, Nelson and Hunton (2006) find that auditors intentionally require

a much greater correction of misstatements in recognized amounts than they do for the same

amounts that are only disclosed. Libby and Brown (2013) show that disaggregation decreases

average auditor materiality thresholds in financial statements, resulting in an increase in the

reliability of the disaggregated amounts as well as the resulting totals and subtotals. However,

this view is not pervasive and decreases the consensus materiality threshold in practice. On

average, auditors also attach a lower materiality threshold for disaggregated information

presented on the face of the financial statements as opposed to the notes (Libby and Brown,

2013).

Communication Principles (Question 18)

Preliminary View. The DP presents the Board’s preliminary view that it would be useful to

develop guidance that promotes the effective communication of useful information for a wide

range of entities. Effective communication reflects the fundamental qualitative characteristic of

faithful representation and the enhancing qualitative characteristics of understandability and

comparability. As a result, the DP proposes six communication principles, namely (1) disclosure

guidance should promote entity-specific information, (2) disclosure guidance should result in

disclosure that is clear, balanced and understandable, (3) disclosure guidance should enable an

entity to organize disclosure in a manner that highlights the importance of information, (4)

disclosures should be linked so that the relationships between the items in the primary financial

statements and the notes are understandable, (5) disclosure guidance should seek to avoid the

duplication of information, and (6) disclosure guidance should seek to optimize comparability of

information without compromising the understandability of entity-specific circumstances.

Response. We agree with the view that the Conceptual Framework should contain

communication principles which could guide the Board in setting future disclosure requirements

in standards. It is not clear to us why these communication principles should only reflect three of

24

the six qualitative characteristics. In our view, the communication principles should reflect both

fundamental qualitative characteristics and most of the enhancing qualitative characteristics. For

example, the concern expressed in paragraph 7.2 of the DP that certain disclosure requirements

in IFRS are not focused on the right disclosures and are too voluminous, could be addressed

through a principle based on the qualitative characteristic of relevance.

Section 8 Presentation in the statement of comprehensive income—profit or loss and other

comprehensive income

Profit or loss subtotal

Preliminary view: The DP (¶8.11 – 8.18) discusses the Board’s ideas about measuring

financial performance and concludes that financial performance is not equated with either total

comprehensive income or profit/loss, as all items in OCI and profit/loss provide some

information about financial performance. In spite of this view, the DP (¶8.19 – 8.22) presents the

Board’s preliminary view that the Conceptual Framework should require a total or subtotal for

profit or loss. The Board is persuaded by the arguments set out in ¶8.20:

“(a) users of financial statements are primarily interested in information about profit or loss

and its consequences on the entity’s capacity to pay dividends and to meet its obligations.

Presenting profit or loss as a total or subtotal therefore supports users’ needs.

(b) profit or loss excludes remeasurement gains and losses that are potentially less predictive

of future net cash inflows because they are not likely to persist or recur and are subject to future

changes in estimates or prices. In addition, some remeasurements, such as those that result from

factors such as changes in interest rates, tend to unwind automatically over the life of the

remeasured asset or liability. Consequently, the profit or loss total or subtotal has more predictive

value than total comprehensive income.

(c) profit or loss can be more closely aligned to an entity’s business model than total

comprehensive income and therefore provides information from the perspective of management

about how the entity’s resources have been used.”

Response: We agree that it is difficult to partition non-owner-related changes in equity into a

component that reflects financial performance (i.e., to include in profit/loss) and another

component that does not (i.e., to include in OCI). Arguments have been made to justify such a

partitioning based on many different attributes: operating/non-operating, realized/unrealized,

persistent/transitory, predictive/non-predictive, value-relevant/non-value relevant. However,

none of these attributes, singly or in combination, has yielded a clear and operationally

satisfactory conceptual basis for partitioning non-owner changes in equity into financial

performance and “other”. As such, this partitioning remains ad hoc in current accounting

standards.

We recommend that a subtotal for profit or loss not be required in the Conceptual Framework,

unless the Board can lay out a clear conceptual basis for such a partitioning, which can be

operationalized in a reasonable way. We believe that providing a statement of comprehensive

25

income, with appropriately disaggregated information, but without a subtotal for profit/loss (and

thus without recycling) will be superior to a statement partitioned on an ad hoc basis.11

Related academic literature and discussion: Advocates of OCI reporting often argue that OCI

gains and losses are transitory in nature, and thus should not be regarded as representative of a

firm’s recurring earnings. This is consistent with the arguments by which the board is persuaded

mentioned above. Dhaliwal, Subramanyam and Trezevant (1999) conducted one of the earliest

studies on OCI, following the release of SFAS No. 130 in the United States. They report that

comprehensive income is not a better summary measure of firm performance than net income.12

Chambers et al. (2007) claim, using actual measures of OCI, that OCI is priced on a dollar-for-

dollar basis and at a lower valuation multiple than net income, consistent with the economic

theory that OCI items are transitory. Various other studies also show that OCI has characteristics

that differ from those of items included in profit or loss (e.g. Cahan et al., 2000; Kanagaretnam et

al., 2009).

Some view the crux of the OCI debate as the lack of a precise definition of financial performance

or earnings. Rees and Shane (2012) review alternative “candidates” for inclusion in profit and

loss (i.e., core items, persistent items, items under management control, remeasurements) but

conclude that, with the exception of remeasurements, these “candidates” are continuous in

nature, which leads to difficulties in implementing a partition and potential for manipulation.

Barker (2004) also presents an in-depth discussion of this issue and concludes that defining an

economy-level definition of financial performance that affects multiple firms with differing

economic characteristics and contracting arrangements is not a realistic objective for a standard

setter. Barton et al. (2010) present evidence that no performance measure (e.g., net income or

total comprehensive income) dominates around the world. They conclude that “standard-setters

should focus not on what performance measure is “best” at a given point in time, but on the

underlying attributes that investors find most relevant (p. 753).

The Board agrees with the view that users of financial statements are primarily interested in

profit and loss. However, the literature shows that financial statement users (e.g., analysts) are

skilled at selecting the components of earnings they believe to be most useful in forecasting

future cash flows and earnings if they are disclosed or presented in the financial statements. For

example, researchers have studied the rapid increase in voluntary reporting of non-GAAP

earnings in the 1990s in the United States.13

Dichev and Tang (2008:1455) characterize this

increase as an attempt to clarify “the important distinction between persistent and recurring

components of earnings [and] sporadic and non-recurring components”. Hence, firms often

engage in non-GAAP earnings reporting in an attempt to provide an improved measure of GAAP

earnings for the purposes of predicting future cash flows and firm value by disaggregating non-

11

This sentiment is communicated even more strongly by Rob Bloomfield in his dissent to the committee opinion

presented in Ohlson et al. (2010, p. 484). He states that “[d]isaggregation of disclosure should be considered a key

desirable quality of financial reports, and the privileged presentation of any income number other than total

comprehensive income should be considered a key undesirable quality of financial reports.”

12 Dhaliwal et al. (199) used “as if” measures of comprehensive income, because they conducted their study prior to

the effective date of SFAS 130. 13

We use the term “non-GAAP earnings” to refer to both analysts’ and managers’ exclusions from GAAP earnings.

In the literature, manager reported non-GAAP earnings is known as pro forma earnings, while analyst reported non-

GAAP earnings is known as Street earnings.

26

recurring items from recurring items (Bhattacharya et al., 2007; Kolev, Marquardt and McVay,

2008).

Some researchers suggest that non-GAAP earnings is a better summary measure of performance

than GAAP earnings. For example, Bradshaw and Sloan (2002) initiated a line of research which

shows that alternative earnings measures - in their case, Institutional Broker’s Estimate (I/B/E/S)

earnings, which exclude various non-recurring items reported under GAAP - are more value

relevant than GAAP earnings in the United States. Brown and Sivakumar (2003) report similar

findings. Bhattacharya et al. (2003) investigated actual non-GAAP press releases, and, using

short-window abnormal returns, report that non-GAAP earnings is more informative and

persistent than GAAP earnings. Entwistle, Feltham and Mbagwu (2010) extended these studies

by showing that actual non-GAAP measures contained in earnings press releases are

significantly more value relevant than I/B/E/S earnings, which in turn are more value relevant

than GAAP earnings.

A concern with value relevance studies on non-GAAP earnings initiated by managers is that,

because the reporting of non-GAAP earnings is voluntary, managers often use non-GAAP

earnings reporting in opportunistic ways. Hence, it is not clear whether the higher value

relevance attached to non-GAAP earnings relative to GAAP earnings is genuine, or is a result of

investors’ being misled by managers. However, Venter, Emanuel and Cahan (2014) discuss the

use of mandatory non-GAAP earnings in South Africa, where managerial motivations for this

kind of opportunistic reporting is minimized by the fact that such reporting is mandatory. They

present evidence that non-GAAP earnings reported under such a mandatory regime has higher

value relevance than GAAP earnings. In addition, Venter, Cahan and Emanuel (2013) show that

the mispricing of special items (non-recurring items recognized in profit or loss) in the United

States, documented by Dechow and Ge (2006), is not evident in the South African setting where

reporting non-GAAP earnings is mandatory. This evidence suggests that when the reporting of

non-recurring items is compulsory, investors are able to price earnings components in a manner

which is consistent with the actual persistence of these earnings components.

In a related stream of literature, there is extensive discussion of a group of gains and losses

referred to in the U.S. as “special items.”14

Special items are relevant to the OCI debate because,

like OCI, they are assumed to be transitory or non-recurring. However, unlike OCI, special items

are recognised in profit or loss. Various researchers present empirical evidence showing that the

value relevance of special items is lower than other components of earnings (Cheng, Liu and

Schaefer, 1996; Collins, Maydew and Weiss, 1997; Dechow, 1994; Easton, Shroff and Taylor,

2000). This is consistent with the argument that special items represent transitory income items

(Collins et al., 1997). In addition, most special items reflect losses. Basu (1997) argues that “bad

news” (losses) has less of an impact on prices than “good news”. In addition, Dechow and Ge

(2006) present evidence that the cash flow component of earnings has higher persistence than

pre-special item accruals, which in turn is more persistent than special items.

14

These items are identified by Compustat from income statements and footnotes. The composition of the “special

items” data item is determined, not by a formal definition specified in GAAP, but rather by Compustat’s own

definition (Burgstahler, Jiambalvo and Shevlin, 2002; Chen and Wang, 2004).

27

Jones and Smith (2011) compare OCI and special items in terms of value relevance, persistence,

and predictive value. 15

They show that special items exhibit zero persistence, whereas OCI items

exhibit negative persistence, which suggests that OCI items partially reverse over time. OCI is

value relevant, but less so than special items and other net income. Special items predict future

net income and cash flows for at least five years, whereas OCI predicts future income only one

year ahead. Jones and Smith (2011) view their findings as strong support for providing

disaggregated information about both special items and OCI. However, they note that using their

results to determine presentation (i.e., inclusion in profit/loss or OCI) depends on the criteria

standard-setters select (i.e., predictive value, persistence, and/or value relevance). For example,

Jones and Smith (2011) note that if standard setters focus on predictive value, their results can be

viewed as supporting the inclusion (exclusion) of special item gains and losses (OCI gains and

losses) in net income. However a focus on persistence would raise questions about including

special item gains and losses, which are largely transitory, and would raise questions about how

to treat OCI income gains and losses, which exhibit negative persistence (albeit possibly due to

recycling).

It therefore follows from our discussion above that the academic literature supports the claim that

OCI gains and losses have different degrees of persistence, predictive ability and/or value

relevance compared to items currently included in profit or loss. We believe this research

supports the idea that disaggregating OCI gains and losses from other items of income and

expense could assist users of financial statements in assessing the amount, timing and uncertainty

of future cash flows. However, the literature also shows that special items and non-GAAP

earnings exclusions have different persistence, predictive value and value relevance from other

items included in profit or loss. This inconsistency raises a number of questions about the

desirability of adopting different accounting treatments for items with similar

characteristics.Further, while the findings in the OCI literature support presenting disaggregated

information about items with different levels of persistence, predictive value, and value

relevance, there are many approaches to providing disaggregated information. The literature does

not show that disaggregation should be achieved by a partition between profit/loss and OCI .

In conclusion, we do not believe that retaining the distinction between profit or loss or OCI can

be conceptually justified. The DP attempts to conceptualise OCI inductively from existing OCI

practices. However, the existing OCI practices do not have an adequate conceptual basis,

because they are the outcome of political pressure on the IASB to oppose recognising income

and expenses in profit or loss.16

Admittedly, one can identify some characteristics that the

existing items of OCI have in common, but there are other items in profit or loss that share

similar characteristics.

15

We refer the reader to our discussion of persistence, predictive ability (or value) and value relevance in our

discussion of Section 7. Also see Francis et al. (2004) for an overview of earnings attributes. 16

For example, in response to pressure from EU leaders and regulators during the financial crisis, the IASB

amended IAS 39 to allow the recognition of fair value adjustments on financial instruments in OCI instead of profit

or loss.

28

Recycling (Question 20)

Preliminary view: The IASB’s preliminary view that the Conceptual Framework should

permit or require at least some items of income and expense previously recognized in OCI to be

recognized subsequently in profit or loss, i.e. recycled, is discussed in paragraphs 8.23 – 8.26.

Response: As we do not support segregated reporting for OCI gains and losses, the question

about recycling is irrelevant, in our view. That is, comprehensive income is an income measure

and therefore recycling would not be appropriate because the items have already been reflected

in a performance measure.

Approaches to OCI (Question 21)

Preliminary view: In the DP, two approaches are explored that describe which items could be

included in OCI: a narrow approach (Approach 2A described in paragraphs 8.40 – 8.78) and

broad approach (Approach 2B described in paragraphs 8.79 – 8.94).

Response: Consistent with paragraph 8.34(a) of the DP, we believe that identifying the

distinguishing characteristics among items currently recognized in profit or loss or OCI is the

core issue in Section 8. Table 8.1 sets out possible attributes that could distinguish items of OCI

from profit or loss (unrealized, non-recurring, non-operating, measurement uncertainty, long-

term items and outside management control). As we have highlighted in our literature review,

many items that have attributes similar to items of OCI are currently recognized in profit or loss.

The problem with using the attributes in Table 8.1 to distinguish between profit or loss and OCI

is that they are not dichotomous, but fall along a continuum It is therefore not possible to

standardize the point on the scale at which the distinction is made without using ‘bright line’

rules. Hence, we agree with the IASB that these attributes are not useful for making a distinction

between profit or loss or OCI. This does not imply that users of financial statements do not find

information on income and expense items that possess these attributes useful. In fact, the

literature on special items and non-GAAP earnings suggest that users of financial statements do

use disclosures in financial statements to come up with alternative earnings measures to GAAP

earnings.

The IASB bases Approaches 2A and 2B in the DP on three principles. Principles 1 and 2 deal

with the distinction between profit or loss or OCI, and Principle 3 deals with recycling. In our

discussion, we focus on the first two principles, because we believe that Principle 3 is only

meaningful once a conceptually justifiable distinction between profit or loss or OCI has been

established.

Principle 1 treats profit or loss as the “primary source” of information about an entity’s return on

its economic resources, whereas Principle 2 stipulates that recognizing an item in OCI is only

appropriate when it “enhances the relevance” of profit or loss. Because a “primary source” and

“relevance” are not dichotomous, but vary along a continuum these principles have the same

flaws as the attributes mentioned in Table 8.1. In fact, these principles capture the attributes in

Table 8.1 in different words. For example, “non-recurring” and “non-operating” items may be

regarded as items that do not form part of an entity’s “primary” source of information on its

returns. Similarly, many of the arguments used for non-GAAP earnings could explain why the

29

exclusion of “non-recurring” and “non-operating” items from profit or loss could “enhance the

relevance” of profit or loss.

Regardless of our view on OCI, we acknowledge, in line with other academics, that users of

financial statements need an earnings figure number that can be used for valuation purposes

(Barker, 2004; Bromwich et al., 2010; Dichev, 2008; Dichev and Tang, 2008; Ohlson, 2006;

Rees and Shane, 2012). We believe that this can be achieved with disaggregated disclosures or

an alternative presentation format for the statement of comprehensive income based on the

concept of “remeasurements”. The most significant advantage of remeasurements is that it is less

subjective than the attributes listed in Table 8.1 of the DP, as it does not vary along a continuum.

Once a remeasurement has been defined, a component of profit or loss is either a remeasurement

or it is not. Despite the ease with which remeasurements can be identified, it provides useful

information to the users of financial statements about items of comprehensive income. This is

because remeasurements often exhibit the attributes mentioned in Table 8.1 – they are unrealized

and may be non-recurring, may be outside management control and may be subject to

measurement uncertainty.

Previously, accounting standard setters have made various proposals to incorporate requirements

in the standards that oblige firms to provide information on remeasurements. Such proposals go

back as far as 2001, when the matrix format of the income statement was developed by the IASB

and the United Kingdom Accounting Standards Board (UK ASB). The objective of that project

was to ensure that the presentation of financial results would enhance users’ understanding of an

entity’s financial results by presenting a line-by-line disaggregation of the income statement into

columns for “remeasurements” and “before remeasurements” (Barker, 2004). Barker (2004)

argues in favour of the matrix format. Tarca et al.’s (2008) experiment to assess the potential

benefits of the matrix format shows that the matrix format improves the accuracy with which

users extract financial information from an income statement.

More recently, the IASB and the FASB developed a reconciliation schedule which requires an

entity to include a schedule in the notes to the financial statements that reconciles cash flows

with comprehensive income on a line-by-line basis, and disaggregates comprehensive income

into four components: cash, accruals other than remeasurements, remeasurements that are

recurring fair value changes, and remeasurements that are not recurring fair value changes

(IASB, 2008). However, the suggested reconciliation schedule has been criticised by the Boards’

stakeholders, mainly due to the complexity of the preparation of the schedule (IASB, 2009c).

Despite such criticism, academic research supports this kind of detailed disaggregation (Dechow

and Ge, 2006; Lipe, 1986; Ohlson and Penman, 1992; Sloan, 1996).

Another example of the use of the concept of remeasurements is headline earnings reporting in

South Africa. The headline earnings definition was originally developed by an analyst society in

the United Kingdom in 1993 in an attempt to produce a standard definition of earnings that could

be used to calculate price-earnings ratios (PERs) on a consistent and comparable basis across

firms (Damant, 2003). Although South Africa is the only country where the disclosure of

headline earnings information in the financial statements is mandatory, the headline earnings

concept is also used for the calculation of PERs in the Financial Times for firms in the United

Kingdom. Hence, the headline earnings definition has proved to be robust and practical in

30

London and Johannesburg for more than a decade. Academic research supports the argument that

headline earnings can assist investors in capital allocation decisions (Venter et al., 2013; Venter

et al., 2014).

A matrix format for the income statement and headline earnings are both simple presentation and

disclosure requirements to implement, and can be easily amended to operate at a comprehensive

income level, as opposed to a profit or loss level.

31

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