Taking a big step toward erecting a stronger foundation beneath the world's accounting standards, the International Accounting Standards Board and the Financial Accounting Standards Board recently issued a joint document suggesting a more clearly defined objective of financial reporting, and more clearly delineated qualitative characteristics of decision-useful financial information.The preliminary views document, the result of Phase A of the boards' conceptual framework project, eliminates small but crucial differences in the basic building blocks of the accounting principles promulgated by the boards. Decisions at this fundamental level will ripple through accounting principles established over the course of decades, and could necessitate amendments to current standards.
Rebecca McEnally, vice president of advocacy at the CFA Institute, expressed strong support for the framework project, but was reluctant to predict how these first chapters would affect the rest of the framework and the standards derived from it.
"At the end of the day, the measure of a sound and successful conceptual framework is whether the principles embodied in the framework can serve as a benchmark for evaluating the quality of a new standard," McEnally said. "Users of the financial statements will make resource allocation decisions, and bear risk based on those decisions. Thus, the principles in the conceptual framework must lead directly to recognition and measurement standards that ensure that financial statements prepared in compliance with the standards will reflect the full economic effects of transactions and activities of the company."
FASB senior project manager Ronald Bossio said that the document represents more changes for the IASB than for FASB. "Phase A has not, to date, resulted in significant changes to the frameworks, in that the objective is still to provide information that is decision-useful to investors and creditors, existing and potential," Bossio said. "The key difference is for the IASB, rather than FASB."
Broaching the question of whether the objective of the framework should be financial reporting, as FASB's Concepts Statement No. 1 states, or financial statements, as the IASB's framework states, the boards concluded that the focus should be on reporting as a whole - that is, broad enough to encompass information that might someday be required outside of financial statements.
"This phase does not define or limit the boundaries of reporting," Bossio said. "That will be discussed in Phase E. There we get into the broader questions of management commentary, and things the Securities and Exchange Commission covers in 10K forms and proxy statements. Some would like to get into governance issues and environmental issues. There's a whole range of people who would like to push the boundaries of reporting."
Chapter 2 of the document deals with the qualitative characteristics of financial information. Bossio said that changes from the boards' current frameworks are essentially a matter of terminology, not substance.
The boards' current frameworks link notions of relevance and reliability, but the document establishes that information is relevant if it is capable of making a difference in a decision. The term "reliability" has been changed to "faithful representation," to avoid questions relating to verifiability.
"Whether these changes in terminology will help understandability is part of what this comment process is about," Bossio said. "This isn't a change in substance, but it is a change in importance in terms of communication."
The issue of stewardship may be one of the more controversial parts of the document. Rather than present management's stewardship of entity resources as an objective of financial reporting, the document subsumes stewardship within the decision-usefulness objective. Two IASB members presented alternative views on that point.
In an interesting departure from FASB's current thought, the qualities of decision-useful information - relevance, faithful representation, comparability and understandability - have been taken out of a hierarchical structure and simply listed without ranking them by importance or precedence. The qualities are subject to two constraints: materiality, and benefits that justify costs.
"The ideas set out in the document ... are some of the most fundamental in accounting," said IASB Chairman Sir David Tweedie, in a prepared statement. "We are therefore keen to receive views on these proposed enhancements as we work towards establishing a more effective and sound foundation to guide us in the development of future accounting and reporting standards."
The boards are soliciting comments from around the world and hope to issue an exposure draft in 2007. The document is available online at www.fasb.org. Comments are requested by Nov. 3, 2006.
