Harmonisation or Discord

1
Harmonisation or Discord?

• The Critical Role of the IASBs Conceptual
  Framework
• Geoff Whittington
• CFPA, Judge Business School, Cambridge

2
The Success of IFRS in Harmonisation

• EU adoption, 2000 and 2005
• Adoption in Australia and other individual
  countries (gt100 use IFRS in some form)
• Convergence with USA (Norwalk Agreement, 2002,
  Roadmap 2005, SEC abandons reconciliation, 2007)
• Convergence with Japan, China, etc.
• Projected adoption by Canada, Brazil, India etc.

3
The Demand for Harmonisation

• Globalisation of Business
• Lower costs for preparers and users.
• Higher confidence (lower cost of
• capital?
• Evidence is success of IASC (voluntary)

4
But Discord also

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

5
Why Discord?

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

6
The Role of the Conceptual Framework

• Harmonisation
• Consistency between standards
• Comparability across entities
• Comprehensiveness (filling gaps IAS8 )
• Principles base ( simplicity and flexibility)
• Discord over choice of concepts

7
The IASB/FASB Conceptual Framework Revision

• Essential for convergence (and improvement)
• Existing IFRS Framework is similar to FASB, but
  shorter and some important differences
• Many new adopters had not bought in to existing
  Framework and are objecting to that
• ( Anglo-Saxon accounting' reinforced by
  FASB convergence)

8
The Revision Programme

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

9
Some Discordant Themes

• Chapters 12, discussion papers, received a
  hostile reception that surprised IASB
• The central issue is stewardship, but the
  underlying cultural differences will affect later
  chapters .

10
Objective of Financial Reporting (Chapter 1)

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

11
Whats Special about Stewardship?

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

12
Implications for Financial Reporting

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

13
Evidence of Cultural Origins

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

14
Why does it matter?

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

15
Qualitative Characteristics (Chapter 2)

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

16
Other Characteristics

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

17
Elements and Recognition

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

18
Importance of Recognition Criteria

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

19
IAS37 Revision

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

20
Liability/equity distinction

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

21
FASBs alternatives for Equity definition (Nov.
2007 DP)

• Narrow Equity, Ownership the preferred method
• Broad equity, Ownership/Settlement
• Reassessed Expected Outcomes (REO) approach,
  with bifurcation of all credits bearing ownership
  risk.

22
AND Related Projects

• Revenue Recognition
• Financial Statement Presentation

23
Revenue Recognition

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

24
Financial Statement Presentation

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

25
AND Things to Come

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

26
Conclusion

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