the comeback of stewardship, reliability and prudence...
TRANSCRIPT
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The comeback of stewardship, reliability and prudence? – An analysis of the IASB’s new
conceptual framework
Abstract
In March 2018, the IASB published its revised conceptual framework which included notable
changes to the chapters on the objective of financial reporting and on qualitative characteristics.
The IASB put more emphasis on stewardship as part of the decision usefulness objective,
reintroduced prudence as an aspect of neutrality and introduced measurement uncertainty (as a
successor to reliability) as part of faithful representation. The present paper analyses the
substance of and reasons for these changes in light of the history of the IASB’s work on
conceptual frameworks. It finds that all three changes mark a significant (though not complete)
step back to the framework that existed before 2010 and follow the IASB’s constituents’
demands. The paper also studies the possible impact of these changes on the IASB’s future
standard-setting by analyzing the other chapters of the IASB’s new framework. The more
pronounced role of stewardship and the reintroduction of prudence serve to clarify the IASB’s
views without changing the existing conceptual approach. In contrast, the introduction of
measurement uncertainty provides the IASB with a necessary conceptual tool to further develop
its thoughts on recognition and measurement and has the potential to substantially impact future
standard-setting debates.
Keywords: Conceptual framework, IASB, IFRS, measurement uncertainty, prudence,
qualitative characteristics, reliability, stewardship.
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1. Introduction
After six years of work on revising its conceptual framework (CF), the International Accounting
Standards Board (IASB) published a new version in March 2018 (IASB, 2018).1 Consisting of
more than 80 pages, the new CF substantially extends the former version from 2010 as it covers
new areas, such as financial statements and the reporting entity, derecognition, presentation and
disclosure, and also includes prolonged sections on recognition and measurement. The official
aim of the document is “[to describe] the objective of, and the concepts for, general purpose
financial reporting” (CF.SP1.1) in order to, primarily, support the future work of the IASB so
that its standards “are based on consistent concepts” (CF.SP1.1(a)).
In the first two chapters of its CF, the IASB outlines what it regards as the objective of financial
reporting and how this can be achieved through specific features of accounting information, the
so-called qualitative characteristics (QCs). Both chapters had already been subject to a joint
review by the Financial Accounting Standards Board (FASB) and the IASB between 2004 and
2010, leading to the publication of a revised CF in 2010.2 Important changes in this document
were – from the perspective of the IASB – the narrowing down of the objective to decision
usefulness with a single focus on valuation decisions, not incorporating stewardship as a
separate concern (Pelger, 2016), the replacement of the major qualitative characteristic
“reliability” by “faithful representation” (Erb & Pelger, 2015) and the abandonment of prudence
that was perceived to conflict with neutrality (Barker, 2015).
In light of the 2010 CF, it is noteworthy that all three major decisions taken by the FASB and
IASB have now been reversed. The terms stewardship and prudence have been taken back into
the CF and “measurement uncertainty” has been introduced as a successor to “reliability”. At
first sight, this might suggest that the IASB has simply re-established the situation from before
2010. This paper aims at addressing the research question to what extent stewardship, reliability
and prudence really experience a comeback in the IASB’s 2018 CF. For this purpose, the
present study first relates the recent changes made in the 2018 CF to prior work of the IASB
(and FASB) on the CF. Second, this paper analyses the other chapters in the new framework,
in particular those on recognition, measurement and presentation and disclosure to find
1 In the following, references to IASB (2018) will be abbreviated as CF with the respective paragraph. CF.BC refers to the basis for conclusions of the new conceptual framework. 2 Correspondingly, the FASB published Statement of Financial Accounting Concept (SFAC) No. 8 (FASB, 2010) which replaced the prior Statements No. 1 (FASB, 1978) and No. 2 (FASB, 1980).
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indications of how substantial the impact of the 2018 changes regarding stewardship, prudence
and measurement uncertainty will be on future standard-setting practice.
The paper finds that the comeback of stewardship, prudence and reliability (in the form of
measurement uncertainty) happened to different extents. First, more emphasis was put on
stewardship as part of the decision usefulness objective but it was not stated as a separate
objective, as it was in the IASB’s CF before 2010. Second, cautious prudence was reintroduced
but the more important step might be the explicit distinction with asymmetric prudence and the
rejection of the latter in the new CF. In both cases of stewardship and cautious prudence no
direct impact on issues of recognition, measurement or presentation and disclosure can be
detected in the rest of the IASB’s CF. It therefore seems that these revisions largely serve the
purpose of clarifying the IASB’s views on these concepts and how they are encompassed in the
existing conceptual structure. Third, the introduction of measurement uncertainty as part of
faithful representation neither perfectly reflects the prior notion of reliability nor is its status
equivalent to the one reliability had in the former IASB CF. Nonetheless, measurement
uncertainty is explicitly taken up in the CF chapters on recognition and measurement which
might imply an important role of this characteristic in future standard-setting deliberations.
This paper intends to contribute to current debates on revisions of the IASB’s CF in the
academic literature. Recently, special issues appeared in Accounting in Europe (Issue 2, 2014)
and Accounting and Business Research (Issue 5, 2015). While several articles in these issues
have addressed important topics emerging from the CF revision (e.g. Barker, Lennard, Nobes,
Trombetta & Walton, 2014) or the use of the CF in standard-setting (e.g. Bouwer, Hoogendorn,
& Naarding, 2015) and practice (e.g. Nobes & Stadler, 2015), none of them discusses the
reintroduction of stewardship, reliability and prudence in the 2018 CF (or in the 2015 Exposure
Draft (ED)). Other literature has discussed (some of) these topics with respect to the joint
IASB/FASB revision. Erb & Pelger (2015) and Pelger (2016) provide qualitative empirical
insights into how the IASB & FASB made their decisions with respect to the replacement of
reliability and the abandonment of stewardship (also see Camfferman & Zeff, 2015, pp. 358-
369). Whittington (2008a) and Barth (2014), as former IASB members, provide insider views
into how changes in the objective and QCs in the 2010 CF might affect future IFRS. Barker and
McGeachin (2015) have contrasted the IASB’s decision to abandon prudence in its 2010 CF
with the use of conservative requirements in a multitude of standards in IFRS, while Barker
(2015) provides the argument that accounting is inherently conservative and thus the debates
on the status of prudence in the CF are largely redundant. In contrast to these studies, the present
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paper focuses on the most recent decisions taken by the IASB and uses the extant literature as
a basis to assess the changes made. Thereby it also complements and updates the comprehensive
historical summary on the objective of financial reporting and QCs by Zeff (2013).
Furthermore, it provides new insights into the possible implications of the changes to the
objective and QCs for future standard-setting.
The paper also intends to provide a basis for future debates on conceptual frameworks. The
IASB concedes that “[t]he Conceptual Framework may be revised from time to time on the
basis Board’s experiences of working with it” (CF.SP1.4). Therefore, an ongoing academic
debate about the importance of concepts is important to provide a foundation for future
deliberations of the IASB.
The paper proceeds as follows. Section 2 provides an overview of the joint IASB/FASB CF
revision with respect to the demotion of stewardship, reliability and prudence. Section 3 then
outlines the reintroduction happened during the IASB CF revision 2012-2018. Then, Section 4
scrutinizes how, on the basis of the other chapters of the CF, the changes made by the IASB in
the 2018 CF might impact its future standard-setting. Section 5 offers some conclusions.
2. Stewardship, reliability and prudence in the CF revision 2004-2010
The IASB and the FASB aimed at converging their accounting standards3 since their formal
commitment in the Norwalk Agreement in 2002. One aspect of the convergence agenda was to
align the basis of standard-setting, i.e. the conceptual frameworks of the IASB and the FASB
(Camfferman & Zeff, 2015, p. 359). Thus, the two boards took the project to revise and
converge their CFs on the agenda in 2004. The boards decided to split up the project into eight
phases (phases A to F), dealing with different parts of the framework. This approach was meant
to enable the boards to achieve progress relatively quickly compared to a comprehensive
revision project (Whittington, 2008b).
The boards started to work on phase A which covered the objective of financial reporting and
QCs, arguably the most general parts of the CF. It was assumed that agreement on these aspects
could be achieved rather easily (Whittington, 2008a) and that on this basis more controversial
issues, on recognition, presentation, and, in particular, measurement, could be discussed in more
depth. The phased approach was also in line with the idea that the later chapters should “flow
from” the objective and the QCs (Johnson, 2004).
3 For an analysis of the convergence efforts see Baudot (2014).
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The following points constituted the major changes from the joint revision project, manifested
in the 2010 version of the CF:
• Stewardship was not included as a separate objective of financial reporting. Instead,
decision usefulness with a sole focus on valuation decisions was stated as the single
objective (CF2010.OB2)4. Stewardship issues were said to be encompassed
automatically in such an objective without the need to be stated separately
(CF2010.BC1.26). It was also decided not to take up the term “stewardship” “because
there would be difficulties in translating it” (CF2010.BC.1.28). This was in notable
contrast to the former IASB framework where stewardship was mentioned as a separate
objective next to decision usefulness (International Accounting Standards Committee
[IASC], 19895, par. 14).6
• The qualitative characteristic “reliability” was replaced by “faithful representation”,
consisting of the subcomponents of completeness, neutrality and verifiability
(CF2010.QC12-16). This replacement was in contrast to both former IASB/FASB
frameworks where reliability, together with relevance, was stated as a major qualitative
characteristic (IASC, 1989, par. 31; FASB, 1980, par. 58).
• The characteristic of prudence was eliminated from the CF. In the former IASB
framework it had been a sub-characteristic of reliability (IASC, 1989, par. 37), while in
the former FASB framework “conservatism – meaning prudence” (FASB, 1980, par.
92) had been discussed in the context of reliability without forming an explicit QC
(FASB, 1980, par. 91-97).
The due process leading to this change consisted of a Discussion Paper (DP), published in 2006
(IASB, 2006), and an Exposure Draft (ED), published in 2008 (IASB, 2008). The proposals in
the DP, reflecting the majority views of the boards,7 largely resembled the final changes in the
2010 CF. However, there was strong opposition by constituents to the proposed changes. For
4 References to IASB (2010) are abbreviated with CF2010 in the following. Again, BC refers to the Basis for Conclusions. 5 The conceptual framework for the preparation and presentation of financial statements (IASC, 1989) had first been developed by the International Accounting Standards Committee (IASC), the predecessor of the IASB, in 1989. For some history of its creation see Camfferman & Zeff (2007, pp. 254-264). When the IASB replaced the IASC in 2001, it adopted the conceptual framework without any changes. 6 However, it was somewhat more in line with the former treatment of stewardship in the FASB framework (FASB, 1978), where stewardship had been included (FASB, 1978, par. 50-53) but the relation to the primary objective of decision usefulness was unclear. 7 There were two Alternative Views in the DP (IASB, 2006). First, Tweedie and Whittington objected to the proposed relegation of stewardship in the section on objectives of financial reporting (AV1.1-1.7). Second, Whittington issued an Alternative View regarding the (sub-)concept of verifiability that, in his view, should include an explicit reference to a factual basis (reliable evidence) (AV2.1-2.2).
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example, in the case of reliability more than 90% objected to its replacement by faithful
representation in the way suggested in the DP (Erb & Pelger, 2015) and similar resistance was
found with respect to stewardship (Pelger, 2016). This negative feedback led the boards to
incorporate some of the criticism in the ED. In particular, stewardship was elevated to the status
of an objective next to valuation usefulness (but within the broader decision usefulness
objective) (Pelger, 2016). However, this solution was only short-lived as the final CF in 2010
went back to the approach of the DP. The reasons for this, in particular, were the powerful (and
dominant) position of US board (and staff) members who were able to assert their positions in
spite of broad opposition by constituents (and some board members). Pelger (2016) shows that,
for the case of stewardship, it was in particular the final “drafting period” in which some staff
and board members, who were convinced that stewardship should not be a separate objective
(and that the framework should not allow any reading in that way), pushed for the abandonment
of stewardship as a separate concern.
The CF revision, culminating in the 2010 publication, reflects a “world-view” in line with a
stronger orientation towards (full) fair value accounting (Whittington, 2008a). It has been
claimed in the literature that the changes to the framework were made with that purpose
(O’Brien, 2009; Power, 2010) and empirical accounts of the boards’ decision-making indeed
show that at least some board members pursued the replacement of reliability because they
wanted to eliminate a hindrance, “a stumbling block on the road to pushing fair value” (IASB
member quoted in Erb & Pelger, 2015, p. 31). In a similar vein, Barth (2014) very explicitly
outlines that, in her view, fair value accounting emerges as the preferred measurement basis
(compared to historical cost and modified historical cost) from an analysis of the objective and
QCs as stated in the IASB’s 2010 CF.
In contrast to their initial expectations, the boards found the completion of phase A of the
framework revision far from easy. Not only did it take six years to finish this phase but also
substantial conflicts emerged among the board members and between the boards and their
constituents with respect to fundamental issues of financial reporting. Due to the difficulties in
phase A and the continuing pressures emerging from the financial crisis, in particular, the
revision of the financial instruments standard and other major convergence projects, the boards
decided in 2010 not to continue with their joint work on the conceptual framework. Even phase
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D on the reporting entity, for which an Exposure Draft had been published in 2010, was put on
hold.8
In 2011/2012 the IASB carried out its first agenda consultation (Pelger & Spieß, 2017). One of
the central messages received by its constituents was that the IASB should continue with the
CF revision. In the words of a (former) board member: “there were a lot of diverse views other
than ‘you need to do the conceptual framework’” (quoted in Pelger & Spieß, 2017, p. 81). When
putting the CF project back to its agenda in May 2012, the IASB decided to continue the project
without the FASB. On the one hand, this reflects the difficulties that the two boards experienced
in phase A, outline above, and increasing difficulties in the convergence program more
generally. On the other hand, the FASB was at that time not eager to restart the project and only
decided to do further work on the CF in January 2014.9
3. Stewardship, reliability and prudence in the CF revision 2012-2018
Initially, the IASB proposed in its Discussion Paper (DP), published in July 2013, not to change
the chapters on objectives of financial reporting and QCs as these had just been overhauled in
the joint project of the FASB and the IASB (DP.1.9.2). However, the constituents’ responses
to the DP gave the IASB the very clear message that some changes were expected (CF.BC1.2,
BC2.2), in particular because “the convergence strategy [with the FASB] is at an end” (Barker
et al., 2014, p. 176).
The IASB followed these demands and in the Exposure Draft, published in May 2015,
suggested revisions to the two general chapters of the CF. First, stewardship was explicitly
mentioned and received more emphasis as part of the objective of financial reporting. Second,
cautious prudence was taken up as a sub-characteristic of neutrality. Third, measurement
uncertainty, intended to capture the meaning attributed to the prior notion of reliability, was
introduced as a new sub-aspect of the fundamental QC “relevance”. As all these changes were
taken through to the final CF – with the exception of measurement uncertainty that was
repositioned to form part of faithful representation instead of relevance –, they will be discussed
in more depth below.10
8 Chapter 2 in the 2010 CF was reserved for the results of this phase but because of the project stop remained empty until 2018. For the other phases, no consultation document had been published until 2010. Only for phase B that covered recognition and measurement first deliberations had been made in board meetings. 9 In contrast to the IASB, the FASB has not yet published an updated CF or parts thereof. For the project status see http://www.fasb.org/jsp/FASB/Page/TechnicalAgendaPage&cid=1175805470156#tab_1175805471232 10 In the words of the IASB, changes were made to Chapters 1 and 2 in the 2018 CF because “the clarity achieved by [their] improvements […] outweighs the disadvantage of divergence in those respects from the FASB’s version” (CF.BC1.3).
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3.1 Stewardship
In Chapter 1 of the 2018 CF on the objective of financial reporting the IASB reemphasizes that
providing decision useful information for resource allocation decisions is the one and only
objective of IFRS (CF.1.2). Therefore, the objective generally remains unaltered compared to
the version from 2010. However, the IASB somewhat broadens its understanding of resource
allocation decisions as this is not only meant to include buying, selling, holding decisions or
decisions about providing or settling loans but also “exercising rights to vote on, or otherwise
influence, management’s actions that affect the use of the entity’s economic resources”
(CF.1.2(c)). Such decisions, which might be termed “stewardship decisions”, encompass
decisions about management’s remuneration or the reappointment or replacement of
management that are particularly relevant for current owners of an entity (CF.BC1.36).
It is noteworthy that the IASB argues in CF.BC1.37 that it never intended a narrow definition
of resource allocation decisions, not capturing such stewardship decisions. This is different
from the account by Pelger (2016) who shows in some detail that the reference to “resource
allocation decisions” instead of the broader term “decisions” (that was still used in the ED from
2008) was incorporated in the 2010 CF during the drafting phase in order to avoid a possible
reading of two types of decisions (valuation and stewardship decisions) and thus two separate
objectives.
The reformulation in the 2018 CF is a clever twist that is supposed to reflect more emphasis on
stewardship concerns without changing the general objective – providing useful information
for resource allocation decisions. Moreover, in its further discussion of the objective, the IASB
explicitly takes up the term stewardship (CF.1.3). It is also highlighted that in addition to the
information about future cash flows, information about management’s stewardship are key in
forming an expectation about the return, for example, from an investment in the firm (CF.1.3).
In the IASB’s own words: “That extra prominence [of stewardship] contributes to highlighting
management’s accountability to users for economic resources entrusted to their care”
(CF.BC1.34).
While the IASB’s efforts to include stewardship in the objective are clearly visible, it is still
maintained that stewardship should not be a separate objective – as it was in the 1989 CF –
because “assessing management’s stewardship is not an end in it itself: it is an input needed in
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making resource allocation decisions” (CF.BC1.35(a)).11 This argument is on thin ground as it
does not specify why assessing stewardship might not be an independent concern. Indeed, the
history of bookkeeping and accounting informs us that stewardship (or accountability) has been
a core motivation to keep accounts and to publish them (e.g. Soll, 2014). Moreover, the
ignorance of separate stewardship concerns is at odds with findings from accounting academia.
Theoretical works have repeatedly questioned whether information needed for valuation
decisions in capital markets are the same as for stewardship decisions (e.g. see Gjesdal, 1981;
Paul, 1992; Kuhner & Pelger, 2015). Such fundamental issues are not addressed by relabeling
the stewardship decisions as a (subgroup) of resource allocation decisions.
3.2 Reliability / measurement uncertainty
As the official motivation to replace reliability had been the different interpretations of the term
(Erb & Pelger, 2015), the IASB did not want to reintroduce it (CF.BC2.30). However, the IASB
decided not to ignore the calls for the concept coming from constituents and introduced
reliability in the new guise of “measurement uncertainty”. The board’s reasoning for this choice
of terminology is interesting: It is argued that two meanings of reliability were used in standards
(CF.BC2.29): First, the meaning of a tolerable level of measurement uncertainty (e.g. in the
2010 CF and then taken up in several standards, e.g. IAS 38.21(a); IAS 37.23). Second, a
qualitative characteristic of useful financial information, that was called reliability and is now
called faithful representation. Thus, the IASB sticks to its prior argument that the replacement
of reliability by faithful representation was only a change in terms but not in substance
(CF.BC2.26). However, there is a notable contrast to the argument in the 2010 CF that the two
notions of reliability were, on the one hand, verifiability, and, on the other hand, faithful
representation (CF.BC2.25, BC2.27), as the IASB now changed the first notion to measurement
uncertainty. Verifiability is positioned as an enhancing qualitative characteristic (CF.2.30).
While the IASB states that “measurement uncertainty makes information less verifiable”
(CF.BC2.48), the exact relation between these notions and the question what else verifiability
might comprise in addition to measurement uncertainty is not addressed in the CF.
The IASB introduced measurement uncertainty to its QCs. However, it was not positioned as a
separate concern but was placed as a subconsideration of the QC “faithful representation”.
Indeed, it is only briefly discussed at the end of the outline of faithful representation when it is
11 It is further argued by the IASB that introducing another objective “could be confusing” (CF.BC1.35(b)) without specifying for whom this might be the case and how stewardship as a separate objective might change the IASB’s thinking.
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mentioned that in cases of estimates “measurement uncertainty arises” (CF.2.19). Strikingly, it
is not explained when and how this impinges on faithful representation but it is argued that
“[e]ven a high level of measurement uncertainty does not necessarily prevent such an estimate
from providing useful information”. This statement suggests a rather limited importance and
reflects a rather hidden introduction of measurement uncertainty. However, in later paragraphs
in Chapter 2 that elaborate on the application of the fundamental QCs (i.e. relevance and faithful
representation), the IASB notes that “the level of measurement uncertainty in making [an]
estimate may be so high that it may be questionable whether the estimate would provide a
sufficiently faithful representation of that phenomenon.” In such situations, this has to be
balanced against the relevance of the information and a less relevant estimate that has a lower
level of measurement uncertainty might be preferred (CF.2.22). Thus, the balancing of
measurement uncertainty and relevance is presented as the exemplar of a trade-off between QCs
and is reminiscent of the trade-off notion that traditionally existed between relevance and
reliability (CF.BC2.53).
The IASB argues that the description of faithful representation in the new CF is “substantially
aligned” (CF.BC2.31) with the description of reliability in the 1989 CF, in other words that the
former concept is now captured in the QC “faithful representation”. However, this argument
ignores one important aspect of the former definition of reliability that is not taken up in faithful
representation: the expression “can be depended upon” (IASC, 1989, par. 31)12. This was
perceived as a central element of reliability, not only in the former CF but also in the general
understanding by the boards’ constituents (Erb & Pelger, 2015). Thus, the question arises
whether the new notion of measurement uncertainty is equivalent to the former expression “can
be depended upon”.
In its new CF the IASB distinguishes three types of uncertainty (CF.6.61). In addition to
measurement uncertainty, it also refers to existence uncertainty, i.e. whether an asset (right,
CF.4.13) or a liability (obligation, CF.4.32) in the definition of the CF does exist, and outcome
uncertainty, i.e. uncertainty about the (amount or timing) of the future inflow or outflow of
economic benefits (CF.6.61). While the development of these three dimensions is analytically
useful, the IASB concedes that sometimes they might be interrelated (CF.6.62). Taking up the
earlier point, all three types of uncertainty would influence to what extent the information
presented in financial reports “can be depended upon”, irrespective of whether the uncertainty
12 The full sentence reads as follows: “Information has the quality of reliability when it is free from material error and bias and can be depended upon by users to represent faithfully that which it either purports to represent or could reasonably be expected to represent.” (IASC, 1989, par. 31).
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is coming from the existence of an asset/liability, outcome or measurement. Thus, the 1989 CF
had a more comprehensive perspective on uncertainties within “reliability”, while the 2018 CF
singles out measurement uncertainty as an attribute of faithful representation.13 As the
expression “can be depended upon” has often been associated with concerns of verifiability
(Erb & Pelger, 2015), it would be important for the IASB to clarify how the enhancing QC
verifiability relates to faithful representation and, in particular, to measurement uncertainty.
With respect to the background of measurement uncertainty, the IASB points to the 2010 CF
and argues that CF2010.QC16 already contained an implicit reference to this concept
(CF.BC2.47). The quote says that measurement uncertainty negatively affects relevance or
usefulness but that it could still “be a faithful representation if the reporting entity has properly
applied an appropriate process, properly described the estimate and explained any uncertainties
that significantly affect the estimate” (CF2010.QC16). This quote gives an indication why the
IASB, in its 2015 ED, first positioned measurement uncertainty as part of relevance. However,
it contradicts the approach taken in the 2018 CF as it states that a faithful representation is
basically independent of concerns of measurement uncertainty. In 2018, the IASB instead
argues that “even if information is subject to a high level of measurement uncertainty, it can be
relevant” (CF.BC2.48(c)). If these statements are more than just “twisting words”, neither
relevance nor faithful representation seem to be the “perfect place” for including measurement
uncertainty and, therefore, its introduction as a third (separate) fundamental QC might, from a
conceptual viewpoint, be a better approach. Furthermore, a more comprehensive notion, such
as “verifiability”, that would encompass measurement uncertainty, might improve the
conceptual clarity in Chapter 2 of the CF. This idea is presented in more detail in Section 5 of
this paper.
3.3 Prudence
Prudence is reintroduced in the 2018 CF as part of the outline of neutrality, one of the subaspects
of faithful representation. It is stated that “[n]eutrality is supported by the exercise of prudence”,
while prudence is defined as “the exercise of caution when making judgments under conditions
of uncertainty” (CF.2.16). The reintroduction of prudence is a reaction to confusion that the
IASB perceived to have been caused by its abandonment in the 2010 CF (CF.BC2.40).
13 Interestingly, existence and outcome uncertainty, in the IASB’s discussion on recognition in chapter 5 of the CF, are positioned as considerations of assessing the relevance of financial information (CF.5.14-5.17).
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While the definition of cautious prudence is identical to the one already employed in the 1989
CF (IASC, 1989, par. 37), prudence is now positioned differently. It used to form part of
reliability and was positioned next to neutrality. Indeed, in the 1989 CF the IASB presents a
description of neutrality (IASC, 1989, par. 36) and then continues: “The preparers of financial
statements do, however, have to contend with the uncertainties that inevitably surround many
events and circumstances […]” (IASC, 1989, par. 37). Thus, there is a link between the two in
that first of all, accounting information should be neutral, i.e. free from bias. However, under
uncertainty that permeates financial accounting activities, prudence should also be considered.
The new CF positions cautious prudence as part of neutrality. The IASB’s argument is that
there is a “natural bias that management may have towards optimism” (CF.BC2.39(a)) and
prudence is intended to counter that bias on the side of preparers, auditors and regulators
(CF.BC2.39(a)) but also to help the IASB to develop standards reducing the risk of management
bias (CF.BC2.39(b)). This view of cautious prudence as a means to achieve neutrality is in line
with the 1989 CF where the two were introduced as complementary rather than opposing
aspects.
However, the approach in the new CF is at odds with the decision made by IASB/FASB in 2010
when prudence was eliminated because it “would be inconsistent with neutrality” (CF.BC2.34).
The reason for this statement lies in a misinterpretation of prudence during the joint framework
revision (Orthaus, Pelger, Kuhner, & Heilmeier, 2018): The 1989 CF explicitly denied any
over- or understatements, in other words, any asymmetric treatments, due to the exercise of
prudence. In standard-setting and among constituents, however, prudence was sometimes
interpreted as leading to asymmetric treatments and such asymmetries have also been
widespread in individual standards regarding recognition, measurement and disclosure in IFRS
(see Barker & McGeachin, 2015, for a comprehensive review). Discarding this practice, the
boards eliminated the term prudence in the 2010 CF, a step that was in particular from an ex-
post perspective controversial as it signaled that the IASB does not (anymore) care about
prudence. Among other things, this led to resistance by the European Parliament14 and, for
instance, the European Financial Reporting Advisory Group (EFRAG) has stated its preference
for explicitly including prudence as a consideration in the CF (EFRAG, 2013a, par. 38). The
need to rethink the issue of prudence was also mentioned in a speech by the Chairman of the
IASB, Hans Hoogervorst, in 2012:
14 See http://www.reuters.com/article/2013/10/14/us-accounting-iasb-idUSBRE99D0KU20131014
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You might very well ask what the heck was wrong with this definition of Prudence? My answer would be: absolutely nothing. The definition basically says that if you are in doubt about the value of an asset or a liability it is better to exercise caution. This is plain common sense which we all should try to apply in our daily life. (Hoogervorst, 2012, pp. 2-3).15
In the new CF, the IASB not only chose to include cautious prudence but also to discuss
asymmetric prudence and to explain that it is not part of the QCs. The main reason is that “a
systematic requirement for asymmetry […] could sometimes conflict with the need for financial
information to be relevant and provide a faithful representation” (CF.BC2.42). While the IASB
concedes that standards might contain asymmetric treatments for dealing with assets/income or
liabilities/expenses, this is regarded as being based on general assessments of relevance and
faithful representation but not as due to asymmetric prudence (CF.2.17). Notably, the IASB
remarks in CF.BC2.44 that “not all asymmetry is inconsistent with neutrality”, a statement in
line with the argument by Barker (2015) of an inherent asymmetry in financial reporting, even
it is strives for neutrality. Along this line it is interesting that the IASB explicitly acknowledges
that neutrality does not entail the aim to show firm value on the balance sheet, does not entail a
recognition of all assets and liabilities and does not require the measurement of all recognized
items at current values (CF.BC2.44). It seems that the IASB’s conceptual thinking with respect
to prudence is far more developed than it was during the prior IASB/FASB revision.
Introducing the distinction between cautious and asymmetric prudence at least provides some
clarity of the IASB’s views.
Figure 1 briefly summarizes the content of Chapter 2 from the 2018 CF.
15 Georgiou (2015) provides a deeper analysis of the political struggles surrounding the re-introduction of prudence into the IASB’s CF.
14
Figure 1: Qualitative characteristics in the 2018 CF
4. The impact of stewardship, measurement uncertainty and prudence in the 2018
CF
This section studies the implications of the renewed emphasis on stewardship and the
(re)introduction of measurement uncertainty and prudence for the other parts of the CF. In other
words, it tests whether the changes to the objective and QCs have any observable implications
on recognition, measurement, and presentation and disclosures. The analysis focuses on the CF
chapters 5 on “recognition”, 6 on “measurement” and 7 on “presentation and disclosure” that
all include conceptual guidance in what the IASB should consider in its specific standard-
setting projects with regard to recognition, measurement and presentation and disclosure
respectively.16
4.1 Recognition
Chapter 5 of the 2018 CF does not specify any general recognition criteria17 but instead provides
guidance on factors that the IASB should consider when thinking about the introduction of such
16 In contrast, Chapters 3 and 4 of the 2018 CF define important terms, among others, the terms “financial statements”, “reporting entity”, “asset”, “liability”. While these definitions are used by the IASB in its future standard-setting activities, they do not have any direct link to the objective and the QCs. Also, chapter 8 which briefly outlines concepts of capital and capital maintenance (and still is copy pasted from the 1989 CF) does include any link. This is corroborated by the IASB very rarely referring to the objective or the QCs in the main text of the CF (the exception to that is a repetition of the objective of financial reporting in CF.3.2) and the BC to these chapters (exceptions are two references to stewardship in the BC Chapter 3 and two cross-references to measurement uncertainty in the BC to Chapter 4). 17 The 2010 CF (identical to the 1989 CF) included two recognition criteria: probability of the inflow or outflow of future economic benefits and reliable measurement (CF2010.4.38).
15
criteria in individual standards. The starting point is that “[a]n asset or liability is recognized
only if recognition of that asset or liability […] provides users of financial statements with
information that is useful” (CF.5.7). Following the fundamental QCs from chapter 2, useful
information is said to be relevant information about the asset or liability and a faithful
representation of the asset or liability (CF.5.7). Chapter 5 does not include any additional
discussion of the objectives of financial reporting. Usefulness can thus be equated with the
objective as introduced in chapter 1. The added emphasis on stewardship does not have any
obvious implications in the chapter on recognition. Instead, the focus in this chapter quickly
turns to the fundamental QCs, i.e. relevance and faithful representation.
Chapter 5 discusses in what way relevance and faithful representation could give rise to
recognition criteria. With respect to relevance it is noted that uncertainty about the existence of
an asset or a liability (CF.5.14) or a low probability of an inflow or outflow of economic benefits
(CF.5.15-18) could restrict the recognition in specific standards. While these two factors are
discussed as possibly limiting the relevance of information, it is not explained how these factors
relate to relevance.18 With respect to faithful representation, the case of high measurement
uncertainty is outlined as a case when “it may be questionable whether the estimate would
provide a sufficiently faithful representation” (CF.5.20). Furthermore, “other factors” are
discussed that include effects of recognition on income, expense and changes in equity, cases
of accounting mismatches and presentation and disclosure issues (CF.5.25). It follows that
measurement uncertainty features as an important consideration in the framework guidance on
recognition criteria next to existence and outcome uncertainty. That the first aspect is positioned
as a part of faithful representation and the other two as parts of relevance seems somewhat
arbitrary. As will be outlined in section 5, considering verifiability, encompassing all three types
of uncertainty, next to relevance and faithful representation might be conceptually superior,
also in the application with respect to recognition criteria.
In contrast to the CF’s discussion of measurement uncertainty with respect to recognition
criteria, this is not done for the other sub-aspects of faithful representation, i.e. completeness,
neutrality and freedom from error. However, the notion of asymmetric prudence is at least
indirectly alluded to in one example provided as part of the description of “other factors” to
consider in setting recognition criteria: CF.5.25(a) states that not only the effects on the
statement of financial position but also on income, expenses and equity should be considered
18 Note that this discussion is also not part of Chapter 2, i.e. existence uncertainty and low probability of flows of economic benefits are not mentioned in Chapter 2 in the context of relevance.
16
by the IASB. The example given is that if an entity acquires an asset in exchange for
consideration, not recognizing the asset would result in recognizing expenses. This might lead
to a misleading representation if the asset is not consumed immediately, but for example, used
over some years (CF.5.25(a)). This example can be interpreted as indicating the need to
consider neutrality in depicting effects through recognition of assets and expenses and not to
promote asymmetric treatments. Correspondingly, in CF.BC5.22 the IASB notes that some
respondents would see measurement uncertainty as a more severe problem for assets compared
to liabilities. However, on the basis of neutrality it is argued that such a general statement is not
valid and asymmetric decisions depend “on the facts and circumstances and so can be
determined only when developing Standards” (CF.BC5.22) but not as a general guideline.
While highlighting the absence of a general asymmetric approach to recognition, the notion of
cautious prudence is not taken up in Chapter 5 and thus is unlikely to influence future standard-
setting in this area.
4.2 Measurement
Chapter 6 first introduces and then describes and contrasts different measurement bases that the
IASB might select in its standards. These bases include historical cost (CF.6.4) and current
value (comprising fair value, value in use/fulfilment value, and current cost, CF.6.11). Then,
the chapter turns to delineate “factors to consider when selecting a measurement basis”. Similar
to the discussion on recognition, Chapter 6 builds on the general idea that
“[t]he information provided by a measurement basis must be useful to users of financial
statements. To achieve this, the information must be relevant and it must faithfully represent
what it purports to represent. In addition, the information provided should be, as far as possible,
comparable, verifiable, timely and understandable.” (CF.6.45)
Again, the notion of usefulness is not further elaborated on and thus the additional emphasis of
stewardship in chapter 1 does not have any direct influence on the content of Chapter 6. Instead,
attention is given to the QCs. When discussing the QCs, the IASB first describes
“characteristics of the asset or liability” and the way the asset/liability contributes to future cash
flows as consideration of relevance (CF.6.49). For faithful representation, the case of
accounting mismatches is mentioned (CF.6.58) before measurement uncertainty is taken up
(CF.6.60):
“in some cases the level of measurement uncertainty is so high that information provided by a
measurement basis might not provide a sufficiently faithful representation […]. In such cases,
17
it is appropriate to consider selecting a different measurement basis that would also result in
relevant information.” (CF.6.60)
In contrast to the chapter on recognition, Chapter 6 also discusses the enhancing QCs, among
them verifiability: “Verifiability is enhanced by using measurement bases that result in
measures that can be independently corroborated either directly […] or indirectly” (CF.6.68).
Thus, both measurement uncertainty and verifiability are included as factors to consider by the
IASB in future standard-setting choices of measurement bases. However, the two are introduced
independently in the main text, as the link between these factors is not explored, in spite of the
IASB’s statement in the BC to Chapter 2 that ““measurement uncertainty makes information
less verifiable” (CF.BC2.48).
Prudence is not mentioned in the main text of chapter 6 and therefore does not reflect a
consideration of the IASB when choosing a measurement basis. This is even more explicitly
stated in BC6.45 which addresses the comment by some constituents that “applying prudence
[…] would imply that the tolerable level of measurement uncertainty would always be higher
for liabilities than for assets”. The IASB rejects this view as it would manifest asymmetric
prudence in the factors used in deciding on measurement bases.
4.3 Presentation and disclosures
The section on presentation and disclosures first introduces three broad principles of effective
communication (CF.7.2). These principles are discussed relatively briefly and do not provide
substantial guidance for the IASB to decide on such issues in future standard-setting. Most
space in Chapter 7 is devoted to a discussion of classification, in particular the classification of
income and expenses. This centers on the question when income and expenses should be
included in the statement of profit or loss or in other comprehensive income (OCI).
The IASB pronounces that the profit and loss is central for determining an entity’s financial
performance (CF.7.16) and therefore, in general, all income and expenses should be included
there (CF.7.17). However, “in exceptional circumstances” the IASB may decide that presenting
income and expenses resulting from changes in current value should be presented in OCI as
this leads to more relevant information or provides a more faithful representation of
performance for that period (CF.7.17). In contrast to Chapters 5 and 6, the IASB does not
elaborate on factors to be considered by the IASB when making this decision. The BC informs
us that this is a deliberate decision but does not provide any argument (CF.BC7.25). For
instance, it is unclear how the notion of measurement uncertainty influences the IASB’s choice
18
between P&L and OCI; whether, for example, high levels of measurement uncertainty in the
estimate of current values would suggest a treatment of value changes in OCI rather than the
P&L.
In the DP from 2013 the IASB included a broader discussion about factors that might be
relevant in making such decisions and mentioned unrealized, non-recurring, non-operating
items as well as measurement uncertainty, long term realization and items outside of
management control (IASB, 2013, Table 8.1). However, the IASB rejected the view that any
(combination) of these factors could help in making a distinction between P&L and OCI (IASB,
2013, par. 8.38). Instead, it suggested in the DP to focus on the question of whether the
relevance of the P&L would be improved by presenting certain items in OCI (IASB, 2013, par.
8.81; similarly IASB, 2015, par. 7.24). The consideration of faithful representation to inform
the distinction between P&L and OCI was only added in the 2018 CF. In the absence of any
operationalization (and examples) of how to apply relevance and faithful representation to this
area, however, not much assistance is offered to the IASB for its future standard-setting.
Another aspect regarding OCI is whether income and expenses included therein should later,
for example, when selling/derecognizing the asset, be reclassified into P&L. The IASB
maintains that if income and expenses were included in OCI this should generally lead to
reclassification into P&L in a later period (recycling). However, this should only be done if it
provides more relevant information or a more faithful representation of the entity’s performance
(CF.7.19). Again, specific factors to consider in the IASB’s choice for recycling are not outlined
(CF.BC7.33).
Neither is stewardship discussed in chapter 7 nor are measurement uncertainty or (cautious or
asymmetric) prudence mentioned. Thus, the impact of the conceptual changes in the 2018 CF
on presentation and disclosure seems to be nonexistent.
5. Discussion and conclusion
In the more abstract parts of its new CF, the IASB has moved back to the times before 2010.
Stewardship has gained higher prominence as part of the decision usefulness objective, but
without being stated as a separate objective. This change does justice to the criticism that has
focused on stewardship “as a matter of emphasis” and has criticized the IASB for its ignorance
of the term in its 2010 CF (e.g. EFRAG, 2013b). A more fundamental issue is that the decision
usefulness objective has – again – not be questioned during the CF revision. If the role of the
CF in providing assistance for the IASB is taken seriously, decision usefulness provides a
19
problematic guideline because it is difficult, if not impossible, to operationalize (see Williams
& Ravenscroft, 2015, for a broader discussion). The IASB tries to avoid these problems in that
the objective, although sometimes mentioned, is not materially considered in the other chapters
of the CF where, instead, the QCs are mobilized to guide, in particular, recognition and
measurement decisions. As a consequence, the heightened importance given to stewardship
does not show substantial effects in the later chapters of the CF. It is also unclear how
stewardship affects the QCs and their balances. The lack of perceivable implications with
respect to stewardship is not surprising given the long-standing debates on what might change
if stewardship were accorded the status of a separate objective. An IASB board member quoted
in Pelger (2016), p. 65, asked: “As a board member, if I place stewardship differently from
valuation, how would I make a different decision in setting standards?” While some attempts
have been made to find examples where stewardship makes a difference (e.g. Lennard, 2007;
EFRAG, 2013b). there have not been many answers to this question. To approach the material
impact of stewardship in addition (or in contrast) to decision usefulness in conceptual and
empirical research (for an example see Cascino et al., 2017) will be important to provide
insights into this fundamental accounting topic.
The reintroduction of (cautious) prudence and the explicit rejection of asymmetric prudence as
part of the QCs clarifies the IASB’s conceptual views on prudence. The former does not
influence the IASB’s CF chapters on recognition, measurement or presentation and disclosure.
Thus, it remains unclear what the consideration of cautious prudence implies for a standard-
setter beyond a signal to preparers, auditors and others that care should be employed in financial
reporting matters under uncertainty. The rejection of asymmetric prudence, however, is
mobilized at a few places later in the documents to argue against treatments that endanger
neutral depictions. Thus, conceptually there is some positive effect of including the distinction
between cautious and asymmetric prudence in the new CF.
Perhaps the most noteworthy change, from the perspective of its effects on other parts of the
CF, is the introduction of measurement uncertainty as a sub-aspect of faithful representation.
This is supposed to act as a successor to the former notion of reliability and is included in the
IASB’s further conceptual thoughts about recognition and measurement. More precisely,
measurement uncertainty serves as a potential barrier when discussing recognition and
measurement questions in specific standard-setting processes.
Conceptually speaking, however, the positioning of measurement uncertainty in the CF does
not seem fully convincing. While the CF regards it as part of faithful representation, the ED
20
from 2015 considered it as a subaspect of relevance. One of the arguments employed in the CF
for positioning it as part of faithful representation might also lead to a different conclusion: “if
the level of uncertainty in […] an estimate is sufficiently large, that estimate will not be
particularly useful” (CF.BC2.47). This argument suggests that a more appropriate place for
measurement uncertainty might be as an aspect of (decision) usefulness, i.e. as a separate
fundamental QC. Thus, a sensible way out of the “uncertainty” whether to include it as part of
relevance and faithful representation would be to state it as a third, independent fundamental
characteristic.
As a further step, it might be worthy to rethink the term measurement uncertainty. While the
relationship between measurement uncertainty and verifiability has not yet been fully explored
by the IASB in its CF, the established term “verifiability” that also formed part of the former
US-GAAP framework (FASB, 1980, par. 81) would seem an obvious choice. Verifiability is at
the core of accounting practice and has been one of the traditionally predominant views of
reliability (Erb & Pelger, 2015). The trade-off between relevance and reliability in the former
CFs basically boils down to a trade-off between relevance and verifiability. Putting verifiability,
currently an enhancing QC in the IASB’s CF, on the level of a fundamental QC would finally
provide the equivalent to the former notion of reliability, including the extent the information
provided “can be depended upon”. Certainly, measurement uncertainty can be regarded as the
most important specification of verifiability in standard-setting deliberations. For example, in
the case of level one fair values, to be taken from an active market, there is no measurement
uncertainty and the information is verifiable. Both is different in cases of market-to-model fair
values where estimates have to be built on the basis of subjective unobservable inputs leading
to indirect verification and measurement uncertainty.
A motivation for the choice of the term “measurement uncertainty” by the IASB might have
been that this does not include outcome or existence uncertainty. While this distinction is
conceptually attractive, it is difficult to uphold in specific cases. For example, high levels of
measurement uncertainty might come together with outcome uncertainty in that the outcome
cannot be readily anticipated. The notion of reliability with its more general claim of “can be
depended upon”, arguably also included questions of existence and outcome uncertainty. For
instance, in the 1989 CF it was stated: “Information may be […] so unreliable in nature or
representation that its recognition may be potentially misleading” (IASC, 1989, par. 32),
21
alluding to what is now called existence and outcome uncertainty.19 Thus, a more
comprehensive term than measurement uncertainty could improve the conceptual clarity in
chapter 2.
Why does the IASB not simply go back and reintroduce “reliability”? The main reason is path
dependency because it clearly rejected the term due to its multiple understandings in the joint
project with the FASB. One of the reasons for these multiple understandings was that reliability
included both verifiability and faithful representation as sub-aspects (Erb & Pelger, 2015).
Notably, the former FASB CF already discussed possible a trade-off between those two sub-
aspects (FASB, 1980, par. 89). This is another reason why it seems odd to position measurement
uncertainty as part of faithful representation.
Therefore, in light of the history of conceptual frameworks and the recent experiences from
framework revisions this paper suggests to introduce verifiability as a third fundamental QC
that includes considerations of all three dimensions of uncertainty discussed in the CF. Figure
2 provides a summary of such an alternative setup of QCs. All three QCs could be applied in
the areas of recognition, measurement, presentation and disclosure.
Figure 2: Alternative setup of qualitative characteristics
19 An example is provided in IASC (1989), par. 32, as the validity and amount of a claim for damages under a legal action might be disputed and thus it may be inappropriate to recognize the full amount of the claim in the balance sheet. This example reflects a case of existence uncertainty (existence of a right/obligation).
22
While the IASB concedes that it will think about a revision of the framework from time to time,
this is not likely to encompass the most fundamental parts on objectives and QCs. Instead, it
can be expected that these chapters will at least have a comparable lifetime to that of the first
IASC/IASB framework, which was more than 20 years. However, this should not restrict
academic research to engage with the objectives and QCs. Recent research has started to use
experiments to explore these topics (Anderson, Brown, Hodder, & Hopkins, 2015; Cascino et
al., 2017) and also, for instance, begun to employ qualitative studies to address the question of
what reliability means in the preparation (and auditing) of accounts (Huikku, Mouritsen, &
Silvola, 2017; Barker & Schulte, 2017). It is to hope that the IASB – when it will start yet
another framework revision at some point in the more or less distant future – can build on more
academic insights that are able to the standard-setters’ conceptual challenges.
This study is subject to several limitations. First, it has solely used publicly observable material
and existing literature as the basis for stating its arguments. Thus, it cannot claim to delineate
the views of the individual IASB board members on the topics discussed but only of the official
pronouncements of the IASB. As a diversity of understandings of the concepts can be expected
among board members (see Joyce, Libby, & Sunder, 1982; Erb & Pelger, 2015), this diversity
is not reflected in the paper. Second, the impact of the changes has only been studied by
focusing on the chapters on recognition, measurement and presentation and disclosure in the
2018 CF. It is not clear to what extent the IASB will actually use these chapters in its future
standard-setting activities, in particular how close it will follow them. The IASB is not formally
restricted by the content of the CF and explicitly acknowledges that it might sometimes deviate
from it (CF.SP1.3). Thus, one might argue that, for instance, stewardship and cautious prudence
play important roles in future standard-setting although they were not taken up in the other
chapters of the conceptual framework. To what extent this will happen is an empirical question
beyond the scope of this paper.
23
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