IASB Discussion Paper for A New Conceptual Framework (July, 2013): A Review
In July, 2013, International Accounting Standards Board (IASB) released a discussion paper “A Review of the Conceptual Framework for Financial Reporting.” In 2011, IASB published an agenda discussion, and it received many feedbacks on the Conceptual Framework project (IFRS 2013). Based on the constituent feedback, IASB reinstated the project. The idea behind the Discussion Paper is to take views and comments into consideration while preparing the future exposure draft and doing the revision of the Conceptual Framework. The primary focus for IASB is to get a review on the areas that are known to have created application issues. Furthermore, IASB wants to update the Conceptual Framework on the basis of the concepts it developed in other projects currently. The major areas falling under the above two categories include definitions of assets and liabilities, measurement, equity, recognition and de-recognition of assets and liabilities, profit or loss and other comprehensive income and presentation and disclosure (IFRS 2013).
The Conceptual Framework in its current form predicates the development of all the International Financial Reporting Standards (IFRSs) developed and issued by IASB. The framework should comprise the concepts that apply to an organization’s financial statements, form the measurement and recognition requirements, define the elements of financial statements and assist parties when transactions and items are not covered in IFRS. IASB was previously very active in proposing revisions to the Conceptual Framework. However, the whole process took a backseat when the financial crisis struck the world economy. Upon receiving the reviews to again restart the Conceptual Framework in the 2011 Agenda Consultation, IASB took the decision to reintroduce the Conceptual Framework revisions through the Discussion Paper (IFRS 2013). This paper will discuss the main focus areas of the Discussion Paper and on what points IASB is requesting comments.
The Discussion Paper shows the intent of IASB to revise the Conceptual Framework. The feedback and comments received in response to the Discussion Paper will be used to determine the points IASB should consider changing while developing the exposure draft for the revised Conceptual Framework. The original Conceptual Framework project was conducted in a phased manner. Different areas of the financial reporting were addressed in different phases. The project started by defining the objective and qualitative characteristics of financial reporting. Then in the subsequent phases, it addressed topics like Elements and Recognition, Measurement and Reporting Entity. Another four topics were planned but they were never touched. In 2010, IASB published the framework for objectives and qualitative characteristics and then created the exposure draft for the next three topics (Deloitte 2014). However, the project was subsequently put on the backburner due to IASB’s focus on other matters. Finally, in 2013, IASB decided to revive the project and published the Discussion Paper on Conceptual Framework (Deloitte 2014). The Discussion Paper focuses only on those areas that have caused application issues in the past during the implementation. The Discussion Paper seeks feedback on those areas which require consistent development of concepts between the recent projects of ISAB and the past Conceptual Framework definitions.
- Definitions of assets and liabilities
- Recognition and de-recognition of assets and liabilities
- Profit and loss and other comprehensive income.
- Presentation and disclosure
- Additional matters.
The Conceptual Framework project is no longer a joint project between IASB and FASB. It solely belongs to IASB now (IFRS 2013). With a less ambitious scope, this project only seeks to rectify the apparent shortcomings and focuses on topics not yet covered.
Assets and Liabilities: Definition
After the introduction, the first section of the Discussion Paper is on the definition of assets and liabilities. Till now assets were defined by resources that had the ability to give economic benefits in the future. Liabilities were defined as a present obligation expected to be settled through an outflow from the current resources. However, IASB has now proposed new definitions for Asset and Liabilities. It has proposed that a present economic resource controlled by an entity should be called an asset and an obligation to transfer an economic resource should be called a liability (IFRS 2013). IASB has now removed the probability (“expected”) part from the definition. IASB has further provided a definition of economic resource to make the definition of asset and liabilities more clear. This chapter also provides definitions for income, expense, payments, receipts as well as contributions to, distributions of and transfers of classes of equity. The next section provides how the new definition will work in the areas in which the past definition of assets and liabilities created problems in financial reporting. Most of the discussions are centered on the term “present obligation” in connection with the definition of liabilities (IFRS 2013). IASB provided three different views, and respondents are requested to make comments.
It seems that the current definition of assets and liabilities fits the organizational situations much better than the previous definitions, but it still has its limitations. According to the current definition, even manpower and improved market position of a company can be termed an asset. It should, therefore, be important for IASB to create a list of asset and liabilities and collect comments on those before creating the exposure draft on the final definition of assets and liabilities (Deloitte 2014). This will eliminate any misinterpretation of the proposed definitions. The present obligation as defined in the present definition encompasses both legal and constructive obligation (EFRAG 2014). IASB seems to favor this definition, but the definition of constructive obligation has some issues. The current definition does not include obligations that issue out of no realistic alternative in the future (For example: future plan to restructure). As per the IASB definition, the plan for restructuring is not a constructive obligation as the entity is not bound to restructure. However, once the implementation of the restructuring plan is in place, the constructive obligation should include the restructuring related outflows as obligation (EFRAG 2014).
Assets and Liabilities: Recognition and De-recognition
Recognition and De-recognition deals with the criterion of assets and liabilities based on which those need to be included or excluded from the financial statement. As per the definition proposed, all assets and liabilities should be included in the entity’s financial statement. The cases in which assets and liabilities may not be included are:
- When recognition results in irrelevant information.
- The cost of recognition of the asset/liability is more than the benefit.
- When recognition, using any kind of measurement, would not lead to sufficiently faithful representation of the assets and liabilities (IFRS 2013).
IASB has also suggested in this section that if some item no longer meets the recognition requirements then it can be de-recognized (IFRS 2013). This is one of the most complete definitions in the Discussion Paper and can be applied to most of the practical cases. There may be some confusion regarding the wording “sufficiently faithful” but this definition is much better than providing a probability value or threshold value for de-recognizing the assets and liabilities. The only improvement to be made in this area is that IASB should add some clarification distinguishing between recognition of an asset (or liability) and de-recognition of an asset (EFRAG 2014).
The fifth section of the Discussion Paper deals with the definition of equity. The basic definition of equity that it is the residual interest still holds true. Equity is still defined in this chapter as the difference between assets and liabilities (IFRS 2013). However, as the definition of liability is changed in the previous chapter, the distinction between equity and liability has become clearer. Also, this section suggests that the financial statement of an entity should present more information on different types of equity in each reporting period. If classes of equity change form, then that also should be reported in the financial statement. This section also reports that if a company is an equity free company, then the most subordinated class of liabilities should be treated in the same way as equity (IFRS 2013).
This section poses some big questions. For example, the current requirement wants different classes of equity to be reported which is not always possible as the definition of equity does not fully clarify which elements are components of equity and which elements are components of liability (EFRAG 2014). In its future Discussion Papers, IASB should, therefore, be more precise on the definition of equity and liability (Deloitte 2014). Till then, this section cannot be included in the future exposure draft for the Conceptual Framework. Moreover, apart from the definition of equity, IASB should provide more insight into interpretation of dilution of equity and rights to receive equity instruments. However, IASB should maintain the definition of equity as the residual liability. In this way, it is distinguished from the liability claims (EFRAG 2014). There are certain entities like Trustee Savings Bank or Co-operative Banks which have residue after the liabilities that, as per the current definition, will be called equity. However, for those entities, there is no claimant for equity. IASB should be clear about these special cases of equity. Also, as per the current equity definition, equity can distinguished from liability as an instrument held by the owners, and any claim on that instrument reduces the liability. However, which instruments contain an ownership interest remains a question to be answered in the current Discussion Paper (EFRAG 2014). It is difficult to separate out equity instrument only based on the ownership claim and most residual element (Deloitte 2014). Especially, it creates problem in the case of a group ownership. In case of insolvency of a parent company, equity holders of the subsidiaries may have higher claim on the assets than the creditors of the parent company. As per the current definition, shares held in the subsidiaries with no controlling interest can be categorized as liabilities and not as equity. IASB in its future Discussion Paper should be clearer on this subject.
Chapter 6 of the Discussion Paper deals with measurement. Now that definitions of assets and liabilities are discussed in the previous chapters, IASB defined appropriate measurement techniques for those. IASB suggested that having one uniform technique to measure all the items of the balance sheet is inappropriate. As per the IASB, measurement is something that should lead to relevant information in the income statement and balance sheet (IFRS 2013).
Conceptually, the suggestion provided by IASB seems solid. However, they are still incomplete. Although IASB recognizes that there should be different measurement processes for determining different items in the income statement and balance sheet, it does not, however, expand beyond that point (EFRAG 2014). This is often observed that a measurement technique used to measure cash flow from the perspective of profit and loss statement and the same measure used for cash flow from the perspective of balance sheet may result in different outcome. Therefore, not only should IASB define what measure should be appropriate for which elements of financial statement, but it should also specify how that measurement technique should be used to determine the changes in assets and liabilities values (Deloitte 2014). This section also brings forth one of the most difficult challenges for IASB in the Conceptual Framework. On one hand, it is universally accepted that a common measurement technique for all elements will be the best way to create financial techniques, but on the other hand having one single measurement technique may result in completely irrelevant data for the financial statement. IASB needs to strike a balance between the two.
Presentation and Disclosure
This is a section that was a part of the original Conceptual Framework project, but it never came into fruition. This is the first time that IASB has provided its views on Presentation and Disclosure requirements of the financial reporting. Presentation and Disclosure mainly concentrates on the differences between elements that are to be included into profit and loss statement and be a part of other comprehensive income (OCI) (IFRS 2013). IASB suggests that all the income and expenses need to be included into income statement unless it is related to the measurement of assets and liabilities. As per the current definition, OCI can be calculated based on one of the two suggested approaches by IASB. The first approach known as narrow approach suggests that the only bridging items (re-measurement used in financial statement) and mismatched re-measurements are to be considered in the OCI. However, the second approach called broad approach suggests including transitory re-measurement items that have a long term realization or settlement period (IFRS 2013).
There are many areas in need of explanation from IASB. For example, IASB should provide more guidance on different elements of the disclosure requirements like what are the components of a line item, what are the items which have disaggregated amounts, how those items fit into the entity’s financial structure and so on. Also, the presentation and disclosure chapter in the Discussion Paper do not touch upon different uncertainties and risks associated with a financial position and how to provide the risk information in the financial statement in a structured way (EFRAG 2014). The current Conceptual Framework has some guidance, but it is so incomplete that many areas are open to several interpretations. There are many risk categories out of which IASB should specify the ones to be disclosed in the financial statement. For example, it is advisable that the risk categories pertaining to measurement uncertainty, potential change in the operating objective, exposure to market and entity’s risk appetite should be included as part of the disclosure requirement in the financial statement (EFRAG 2014).
The last chapter of the Discussion Paper deals with a collection of topics. It discusses the objectives and qualitative characteristics of the financial reporting process and suggests that those should remain unchanged. Furthermore, it discusses the possibility of using business model in the financial reporting and also the unit of account at a standard level (IFRS 2013). IASB believes that the unit of account is best left to the individual IFRS’s, but there should be some guidance developed for the business model based financial reporting for more relevant information (IFRS 2013). This chapter also discusses the concept of capital maintenance and reporting requirement in case a company ceases to be a going concern. This section is also intent upon seeking comments and inputs from different sectors of the business.
The Conceptual Framework was originally an ambitious project of IASB and FASB, but later was parked after the global financial crisis. However, in 2011, the project restarted on the basis of the feedbacks that came from the financial community. However, it is now a project of IASB alone. This is the first Discussion Paper after the project restarted. IASB through this Discussion Paper has provided some suggestion and views regarding different aspects of Financial Reporting and Conceptual Framework. Some of the areas are well researched, and IASB has provided some really good suggestion which probably will need more clarification before they can be drafted into exposure draft. However, some areas like Presentation and Disclosure, OCI and Measurement standards need more evaluation. Probably before an exposure draft can be created for those areas, another Discussion Paper will be required from IASB. However, to build the Conceptual Framework, this is the step towards the right direction. If this can be continued, then in another few years IASB can come up with the first exposure draft of Conceptual Framework.
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