Ever since the Financial Accounting Standards Board's original Conceptual Framework was established in the early 1980s, we have embraced relevance as a major goal, if not the goal, in bringing meaningful reform to financial reporting.

Specifically, if reported information is irrelevant, then it is of no earthly good. All it does is take up space and send the efforts of a great many accountants, managers and financial statement users down the drain. In addition, nothing can ever make irrelevant data useful, especially audits that merely confirm reported amounts.

This observation opens two avenues for reform. First, standard-setters must not introduce any new irrelevant information into financial reports. Second, they should replace existing standards that produce irrelevant information. In effect, acknowledging relevance's primacy creates a powerful test for usefulness.

Bad news, good news

Of course, relevance was defined in the original framework. It's now back in the forefront through the recently released preliminary views document on the new framework, which is a joint project of both FASB and the International Accounting Standards Board. As we look at it, there is both bad news and good news.

We'll do the bad news first, and it really isn't that bad. Specifically, we wish that the boards had explicitly acknowledged that their role in the reformation process is limited, despite its prominence. Because this quotation doesn't mention other constituents, it implies that they carry the entire burden of initiating reform: "Standard-setters can and should take steps to understand how investors and creditors use financial reporting information and how financial reports might better serve their needs." (Par. BC2.6)

In fact, everyone involved in financial reporting must engage in this task, including managers and auditors. Financial reporting's purpose is to supply information that users demand; it follows that information is worthwhile only if it satisfies those demands. And when user information demands are satisfied, basic economic theory, common sense and extensive research show that managers who voluntarily report relevant information will enjoy a lower cost of capital.

This idea is the crux of Quality Financial Reporting, the demand-driven paradigm that we have advocated for a long time. Of course, standard-setters must understand user demands and do their best to satisfy them, but so should everyone else. It only makes sense.

We hope that this quote does not reflect the attitude that the boards consider themselves to be the only avenue for innovation and progress. Although their leadership role is indisputable, we see standard-setters as perhaps the most inefficient means of creating real progress. By virtue of their public-policy roles, the boards' processes must be slow and deliberate. As a result, managers and auditors have greater opportunities to get out in front of them by initiating innovative, useful reporting practices in their quest for lower capital costs through higher quality.

As for the good news, the boards' document shows that relevance has been clarified and upgraded in the new framework. Here is their proposed new definition: "Relevant information is capable of making a difference in the decisions of users by helping them to evaluate the potential effects of past, present or future transactions or other events on future cash flows (predictive value) or to confirm or correct their previous evaluations (confirmatory value). Timeliness - making information available to decision-makers before it loses its capacity to influence decisions - is another aspect of relevance." (Par. QC8)

Future cash flows

We are pleased to see the definition make a direct connection between relevance and future cash flows. This link is significant because it establishes how relevance is to be assessed. For example, this linkage makes it difficult to defend old historical costs as relevant because there are no automatic connections between those amounts and assets' present ability to affect future cash flows. Knowing, for example, that land was bought for x amount in the past is not relevant to judging how much cash-flow potential it now has.

Predictive value

The document explains that predictive value is not the same as predictions. The essence of analysis and decision-making is anticipating what the future holds, and then preparing to take advantage of the expected events. The definition shows that relevant information serves decision-makers only by helping predict those events. In effect, financial reports should not cross that line by reporting what others have predicted.

We hope that people will sooner or later understand that market values are not predictions, but observations of real facts. This change will occur if the boards define market values as real amounts observed in recent transactions, instead of hypothetical amounts that might be realized in future transactions.

Confirmatory value

The second quality of relevance is confirmatory value, which was called "feedback value" in the original framework. The previous definition was often twisted to justify reporting historical costs so that users could know what management did pay in the past. The context of the new definition clarifies that relevant information should help users confirm that previous predictions were right or wrong.

In other words, confirmatory value does not justify reporting past costs. Rather, relevance can be achieved only by continuously updating financial statement measures to reflect what is known today, so that users can compare it with what they expected yesterday.


The new definition describes timeliness the same way as the old one, namely that management should publish reports on a timely basis. While we agree that timeliness is important, we think it needs to be clarified and expanded.

In our view, timeliness involves much more than publication. Specifically, the contents of reports must be timely, in that they are sufficiently recent to be faithful representations of what exists when the report is issued.

For example, suppose a fire destroys some of a company's assets between the year end and the report release date. Pursuing timeliness causes the balance sheet to omit those assets because they no longer exist and cannot affect future cash flows.

More significantly, timeliness is yet another reason to curtail reporting past amounts. Assets' original costs, or their old market values, simply cannot be timely descriptions of their current ability to affect future cash flows.

Relevance first

We breathed a sigh of affirmation when we read the following: "The boards concluded that relevance is the quality that should be considered first. If information about a particular real-world economic phenomenon is not pertinent to investment or credit decisions, none of the other qualitative characteristics matter. Accordingly, it would be inefficient to consider faithful representation, comparability or understandability for irrelevant items." (Par. BC2.62)

We have argued this point for decades. Paul Miller particularly remembers a 1982 conversation in which he asked a FASB member whether it made sense to identify what is relevant and then seek a reliable measure for it, only to have the member reply that he wanted to find all reliable information and then sift through it for relevant items. It's just as clear now as then that he was desperately trying to steer the framework away from market values so that historical numbers would be retained in practice.

To put this point another way, nothing can be done to make irrelevant information relevant. Therefore, the initial search must discard all that's irrelevant and focus on the relevant. Again, this is another reason to abandon historical costs.

Relevance isn't sufficient

However necessary relevance is to usefulness, the fact remains that it's not sufficient. It does little good to report market values when they are not reliable, or according to the new framework, when they are not representationally faithful.

For example, recent market values of marketable securities faithfully represent their current cash-flow potential. In contrast, a subsidiary's market value is more difficult to assess with representational faithfulness without recent transactions that would provide the needed insight.

Nonetheless, the absence of convenient verification doesn't justify retreating to irrelevant original costs. It does mean that additional effort is needed to create useful information in these cases. For example, information about the sum of the market values of the subsidiary's assets and liabilities could be sufficiently faithful to justify reporting those numbers to approximate what the whole is worth.

What's next?

A future column will take on representational faithfulness, the other equally necessary quality, which, by itself, is also insufficient for achieving usefulness. The boards have taken some big strides in this area as well, and we're eager to help our readers understand what they mean and, more important, what they imply about the future of financial accounting and reporting.

Stay tuned.

Paul B.W. Miller is a professor at the University of Colorado at Colorado Springs, and Paul R. Bahnson is a professor at Boise State University. The authors' views are not necessarily those of their institutions. Reach them at paulandpaul@qfr.biz.

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