Keywords: Conceptual framework, IASB, IFRS, measurement uncertainty, prudence, qualitative characteristics, reliability, stewardship.

Transcription

1 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. 1

2 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 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 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). 2

3 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 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 ). 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 3

4 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 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 The IASB and the FASB aimed at converging their accounting standards 3 since their formal commitment in the Norwalk Agreement in 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 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). 4

5 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], , 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 ). 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 For some history of its creation see Camfferman & Zeff (2007, pp ). 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 ) 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 (AV ). 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) (AV ). 5

6 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 6

7 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 Stewardship, reliability and prudence in the CF revision 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 Chapter 2 in the 2010 CF was reserved for the results of this phase but because of the project stop remained empty until For the other phases, no consultation document had been published until 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 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). 7

8 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 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 8

9 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. 9

10 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). 10

11 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 ). 11

12 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 expost perspective controversial as it signaled that the IASB does not (anymore) care about prudence. Among other things, this led to resistance by the European Parliament 14 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 12

13 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. 13

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 standardsetting projects with regard to recognition, measurement and presentation and disclosure respectively Recognition Chapter 5 of the 2018 CF does not specify any general recognition criteria 17 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 (CF ). 14

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 ) 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. 15

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 standardsetting 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, 16

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 17

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 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 18

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 standardsetter 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 19

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), 20

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 subaspects (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). 21