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A REVIEW OF THE CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

The following report examines Section 6 of the IFRS Conceptual Framework Discussion Paper (2010). The first section of the report will examine the proposed measurement principles and the rationale behind these, aswel as the viewpoints and counter-suggestions of different users of Financial Reports.

Secondly, the report will investigate how the proposed measurement principles aim to reduce complexity whilst improving the overall faithfulness of Financial Reports.

MEASUREMENT PRINCIPLES AND GUIDANCE

MEASUREMENT BASES FOR ASSETS AND LIABILITIES

The first key issue to arise from the Discussion Paper is the topic of how to measure Assets and Liabilities. IASB (IASB, 2013, para. 6.11) states that it could ‘measure all assets and liabilities on the same basis’ and then goes on to suggest two different methods in which it could do that. This method is supported by the Australian Council of Auditors-General who emphasise the importance of a single measurement basis for any conceptual framework (ACAG, 2013), building on another one of the frameworks key concepts – consistency. This would mean that from a potential investor’s point of view, they could look at various entities Financial Reports knowing the each total/sub-total was calculated using the same measurement principles, making it a lot easier for a comparison across entities in the eyes of the investors. Also, Canadian General Accountants comments that an ‘inconsistent measurement basis will be misleading and irrelevant to users of the reports’ (CGAAC, 2013) again supporting the use of a single measurement basis throughout the reports with the aim of not misleading users of the reports.

However, IASB itself argues this point and says that using a single measurement basis is ‘unlikely to provide relevant information’ (IASB, 2013, para 6.13) which is essential in the eyes of potential investors. The IASB is supported in this view by utility trio Edison, who agree that in order to provide the most relevant information, measurements should not be limited to one basis (Edison, 2013) – their belief is that by limiting the measurement to one basis, the most relevant measurement basis may be neglected for the sake of consistency and simplicity.

Three of the big four accounting firms agreed that a single measurement basis would not be adequate, with Deloitte adding that the framework should give a more ‘comprehensive discussion of the measurement bases available, when it would be appropriate to use them and the circumstances when it might be appropriate to

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change a measurement basis’ (Deloitte, 2013) which would greatly improve on the clarity of the proposed principle whilst giving everyone from investors to financial reporters an established system to work with in identifying or implementing a measurement bases.

The 100 Group (2014) develop this point further by suggesting that the IASB should enforce a ‘default’ of measurement base, except in circumstances where a different measurement bases would provide ‘more relevant information’ which again would help provide the most relevant information to users.

However, KPMG supports the proposed measurement principle based on the business model concept that ‘a measurement of an asset should reflect how that asset contributes to future cash flows’ and that measurement of a liability should ‘reflect how the entity will settle or fulfil that liability’ (KPMG, 2014). This viewpoint seems to be supported by the broadest group of users, ranging from the Academic London School of Economics (LSE), to tobacco giants British American Tobacco who also add that using this method will more precisely represent probably cash flows (BAT, 2014) again providing more relevant information to a wide variety of users.

Looking at each argument for or against the use of a single measurement basis it is only a small minority of users who are for such a method, with reasons for this being to improve consistency. However, it’s clear that relevance to users and preparers of reports is more to be desired than irrelevant consistencies. The users who support a multiple measurement basis is much broader, ranging from auditors, academic institutions to commercial giants, all who suggest accuracy and relevance is more important.

THE COST CONSTRAINT

Another big issue within the proposed principles is the cost constraint associated with ‘estimated’ figures. There becomes a trade-off between the subjectivity and relevance of the information, as the more subjective an estimate is the more costly it will be to theorize, and the more subjective the less relevant it is to users of the report. As the Discussion Paper states even if a measurement is the most relevant ‘the benefit to the users of financial statements declines as it comes more subjective (and thus more costly to produce)’. This belief is supported by the International Association for Accounting Education and Research who also state that the ‘benefits of a particular measurement should be sufficient to justify the costs’ (IAAER, 2014) which would mean that relevance isn’t the biggest priority when preparing financial reports, unless the costs of the measurement are justifiable in terms of the benefit they will give to users.

In such a scenario where the subjectivity of a particular measurement is too high, the DP has suggested that the entity should ‘consider different measurement’. Which again is largely supported by other users of financial reports, including the USCC (2014) who put forward that they ‘strongly supports the need for cost-benefit considerations’ in accounting standards.

This particular area of the proposed principles seems to be the most agreeable, with both preparers of financial reports and potential investors seeing the benefit of providing the most relevant and unambiguous information for the optimal cost only, and not above the point where it would be of less benefit to both users.

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COMPLEXITY AND FAITHFUL REPRESENTATION

MINIMUM NUMBER OF MEASUREMENT BASES

There have been many comments regarding how best to trade-off between relevance and faithful representation of information. This is even more prevalent in the principle put forward by IASB that reporters should use the minimum number of measurement bases needed to provide relevant information (IASB, 2013, para. 6.23).

However this is often countered with the fact the minimising the forms of measurements to give the most relevant information will strongly neglect the faithful representation of the data and so it’s argued that as many measurement bases as is necessary to achieve a relevant and faithful representation of the information whilst meeting user needs should be used (NZASB, 2013).

There is much debate over limiting the number of measurement bases within a report, with many different types of users agreeing to the limiting; RSM (2014), WB (2014), IAAER (2014), PwC (2014), and with some also disagreeing; CGAAC (2013), Linde (2013). But not many seem to offer a compromise or solution; however, one that stood out was from UoG (2014) suggesting that IASB should also include standards on how to weigh faithful representation against relevance.

Having IASB establish a system whereby entities can balance the number of measurement bases against both faithful representation and relevance seems to be a great way to improve transparency and also the overall faithfulness of the reports.

EFFECTS ON COMPLEXITY

A fundamental aim of new principles is that all parties are in understanding of how they work and why a particular method is chosen etc. So now we will look at some cases where Section 6 has either reduced, or increased the complexity of measurement.

Firstly, discounted cash flows and discounts rates are mentioned numerous times throughout Section 6 (IASB, 2013, para. 6.42) which has some entities in disagreement; City Group (2014) has put forward discounting only adds to complexity in financial reporting by obscuring their related cash flows, complicating going concern and also reduces reliability due to ambiguous discount rate which the user may or may not agree with.

The ambiguity of the discount rate is a one of three well known inter-relating factors that can affect cash-flow-based measurements, along with the unit of account and the way in which uncertainty was incorporated (Grant Thornton, 2014). Whilst this is a fair argument, discounting cash flows is also a well-established economic theory (IAAER, 2014) that is common knowledge between most users of financial reports and is not a new idea but just one being carried forward and so has not increased nor decreased the complexity of measurement.

Building on the previous section, the proposal to limit the number of measurement bases will help to reduce complexity (PwC, 2014) by cracking down on entities that use several measurement bases with the intention of obscuring their financial reports to become more appealing to other users. However, it is also suggested that

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the categories put forward by IASB are too broad and need to be broken down more to reduce complexity and improve overall understanding for all users and preparers of reports (PwC, 2014).

CONCLUSION

The overall consensus seem to be that the majority of parties agree only partially with the proposed measurement principles, with most suggesting changes need to be made, emphasising on the clarity of the principles and amount of detail involved, whilst also maintaining the most relevant measurements are chosen.

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REFERENCING

Australasian Council of Auditors General (2013) A Review of the Conceptual Framework for Financial Reporting. Letter of comment dated 8 November [online]. Available from: www.ifrs.org [Accessed: November 5, 2014]

British American Tobacco (2014) A Review of The Conceptual Framework for Financial Reporting. Letter of comment dated 13 January [online]. Available from: www.ifrs.org. [Accessed: October 18, 2014].

Center for Capital Markets Competitiveness (2014) A Review of the Conceptual Framework for Financial Reporting. Letter of comment dated 13 January [online]. Available from: www.ifrs.org. [Accessed: October 22, 2014].

Certified General Accountants Association of Canada (2013) Preliminary Views on Financial Statement Position. Letter of comment dated 11 December [online]. Available from: www.ifrs.org [Accessed: November 5, 2014]

City Group P.L.C. (2014) A Review of the Conceptual Framework for Financial Reporting. Letter of comment dated 14 January [online]. Available from: www.ifrs.org. [Accessed: October 26, 2014].

Deloitte Touche Tohmatsu Limited (2014) A Review of the Conceptual Framework for Financial Reporting. Letter of comment dated 14 January [online]. Available from: www.ifrs.org. [Accessed: October 18, 2014].

Edison Electric Institute (2014) A Review of the Conceptual Framework for Financial Reporting. Letter of comment dated 14 January [online]. Available from: www.ifrs.org [Accessed: November 5, 2014]

Grant Thornton (2014) A Review of the Conceptual Framework for Financial Reporting. Letter of comment dated 14 January [online]. Available from: www.ifrs.org. [Accessed: October 18, 2014].

IASB (International Accounting Standards Board) (2014) Discussion Paper DP/2013/1 A Review of the Conceptual Framework for Financial Reporting [online]. London: IASCF. Available from: www.ifrs.org. [Accessed 30 October 2014].

International Association for Accounting Education and Research (2013) A Review of the Conceptual Framework for Financial Reporting. Letter of comment dated [online]. Available from: www.ifrs.org. [Accessed: October 18, 2014].

KPMG IFRG Limited (2014) A Review of the Conceptual Framework for Financial Reporting. Letter of comment dated 14 January [online]. Available from: www.ifrs.org. [Accessed: October 18, 2014].

London School of Economics and Political Science (2014) A Review of the Conceptual Framework for Financial Reporting. Letter of comment dated 12 January [online]. Available from: www.ifrs.org. [Accessed: October 18, 2014].

NZ Accounting Standards Board (2013) A Review of the Conceptual Framework for Financial Reporting. Letter of comment dated 19 December [online]. Available from: www.ifrs.org. [Accessed: October 18, 2014].

PricewaterhouseCooper (2014) A Review of the Conceptual Framework for Financial Reporting. Letter of comment dated 14 January [online]. Available from: www.ifrs.org. [Accessed: October 18, 2014].

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RSM International (2014) A Review of the Conceptual Framework for Financial Reporting. Letter of comment dated 14 January [online]. Available from: www.ifrs.org. [Accessed: October 18, 2014].

The 100 Group Financial Reporting Committee (2014) A Review of the Conceptual Framework for Financial Reporting. Letter of comment dated 13 January [online]. Available from: www.ifrs.org. [Accessed: October 26, 2014].

The Linde Group (2013) A Review of Conceptual Framework of Financial Reporting. Letter of comment dated 9 December [online]. Available from: www.ifrs.org. [Accessed: October 18, 2014].

The World Bank (2014) A Review of the Conceptual Framework for Financial Reporting. Letter of comment dated 14 January [online]. Available from: www.ifrs.org. [Accessed: October 18, 2014].

University of Gothenburg (2014) Comments on Discussion Paper on Conceptual Framework for Financial Reporting. Letter of comment dated 14 January [online]. Available from: www.ifrs.org. [Accessed: October 22, 2014].

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