Six years ago the Financial Accounting Standards Board and the International Accounting Standards Board agreed to work on a joint project to develop an improved, common conceptual framework that would provide more consistent accounting rules. In September, the boards completed just the first phase of their collaborative effort. Slow going, indeed.
As a member of both FASB's Financial Accounting Standards Advisory Committee (FASAC) and IASB's Standards Advisory Committee (now known as the IFRS Standards Advisory Committee) at the time the project was launched, I was ecstatic that the boards acknowledged the need to address the conceptual framework jointly as they embarked on an aggressive convergence plan. The idea was to have a single framework that would serve as the foundation for the development of accounting and reporting standards based on consistent principles.
Unfortunately, the current conceptual frameworks of both boards have not kept pace with the changing directions of some of the issued standards. Why not? Because it hasn't gotten the attention it deserves. At nearly every FASAC meeting, I raised my hand, and asked: “Why aren't we making the Conceptual Framework Project a priority? Before we embark on major projects like business combinations (which had not yet been issued), revenue recognition, and financial statement presentation, shouldn't we all be grounded in the same concepts?” After a few of the board members rolled their eyes, they would give me the standard response: “That would take too long.”
As the boards state in the objective to the project that the “Concepts Statements are intended to set forth objectives and fundamental concepts that will be the basis for development of financial accounting and reporting guidance. The objectives identify the goals and purposes of financial reporting. The fundamentals are the underlying concepts of financial accounting—concepts that guide the selection of transactions and other events and conditions to be accounted for; their recognition and measurement; and the means of summarizing and communicating them to interested parties.”
The boards also explain that they themselves are the biggest beneficiaries of the guidance provided by the Concepts Statements, since it provides a common foundation and basic reasoning on which to consider the merits of alternative ideas. (I can't help but wonder if the boards would be at such an impasse on the financial instruments accounting project, if they were grounded in similar recognition and measurement concepts first?) In fact, IASB acknowledges in its Conceptual Framework feedback document—which discusses how it addressed some of the comments received on the original proposal—that it is more difficult to develop improved and common requirements if each board bases its decisions on a different framework.
I still believe that this project should be a priority; particularly as the big-ticket convergence projects are tackled, wouldn't it be easier to agree on standards if the conceptual frameworks were the same for both boards? If anything, I think that the financial crisis brought a sharper focus on some of the fundamental issues and limitations of financial reporting that need to be addressed before more complex standards are issued.
The project is an eight-phase endeavor, and after only six years, the first phase is now complete! FASB recently issued two new chapters in Concepts Statement 8, Conceptual Framework for Financial Reporting, which supersede Concepts Statements No. 1 (Objectives of Financial Reporting by Business Enterprises) and No. 2 (Qualitative Characteristics of Accounting Information). As the boards complete each phase, new chapters will be added to the conceptual framework.
The first chapter of the new Conceptual Framework states the objective of financial reporting: “To provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors, in making decisions about providing resources to the entity.”
Some respondents to the original proposal pointed out that certain users are not relying on financial reporting to make resource allocation decisions. For example, many make decisions based on the “stewardship,” of an entity's resources, that is, how an entity is managed and makes decisions. I agree. In my view, one of the primary uses of financial statements is to determine how a company managed its business during a certain period. The boards believe that although, the term “stewardship” is not used, it is implied in the objective noted above.
As the big-ticket convergence projects are tackled, wouldn't it be easier to agree on standards if the conceptual frameworks were the same for both boards?
The latest chapter of the Conceptual Framework on qualitative characteristics (Chapter 3) deals with the attributes that make financial information useful. Qualitative characteristics are categorized as either fundamental or enhancing. The boards determined that relevance and faithful representation are the fundamental qualitative characteristics, while comparability, timeliness, verifiability, and understandability are enhancing characteristics. For financial information to be relevant, it must be “capable of making a difference in the decisions made by users.” Information is capable of making a difference in decision making when:
it is a usable input to predict future outcomes,
it offers feedback to confirm or change previous inputs used to predict future outcomes, or
it is both. Relevant information must also be faithfully represented to be useful.
The new framework also acknowledges that cost is a pervasive constraint on the reporting entity's ability to provide useful financial information.
Many of those commenting on the qualitative characteristics were concerned about the perceived “demotion” of reliability in the Conceptual Framework. Based on the final standard the boards were not persuaded by the argument that reliability should be a fundamental characteristic. Therefore, faithful representation, which is defined as a representation that is “complete, neutral, and free from error” remained. (I can't help but think of Stephen Colbert's word, “truthiness” when I think of faithful representation.) Chapter 3 notes that the usefulness of the fundamental characteristics is “enhanced if it is comparable, verifiable, timely, and understandable” and that such enhancements also should be “maximized to the extent possible.”
I would be remiss not to point out that for many dealing with fair-value accounting issues, the argument was steeped in the “relevance” vs. “reliability” debate, since both were primary qualities in the previous Conceptual Framework. Some believe that fair value is a more relevant measure, but acknowledge that when balanced against the other primary characteristic of reliability, it may not be the most appropriate measure for items that do not have a ready market. By replacing reliability with faithful representation, are we setting ourselves up for more fair-value accounting in the future? How will auditors deal with this nuance? Will the wording of the audit opinion need to change to reflect the new fundamental characteristics of financial reporting?
There are currently several active phases of the eight-phase project, including the Reporting Entity Concept for which an exposure draft was issued in March 2010. Discussion papers are expected some time in 2011 for the other active phases, the Measurement phase and the Definitions of Elements, Recognition, and De-recognition phase.
It could be several years before all the phases are complete. But ultimately, the timing of the Conceptual Framework final standards may not matter, since the framework is often just playing “catch up” to standards that have already been issued using a new unpublished framework that the boards have apparently agreed to, but have not made public. But if the boards want to keep moving down the road to convergence, they will have to make the common conceptual framework a priority.
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