Harmonisation or Discord?

1. Harmonisation or Discord? The Critical Role of the IASB’s 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 (>100 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 1&2, 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. What’s 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 FASB’s 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. FASB’s 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 framework…but 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?