Conceptual Framework- Chapters 1 and 2—Cover paper- Agenda paper 10

Background

The purpose of this session was to discuss whether any amendments are needed to Chapter 1 — The objective of general purpose financial reporting and Chapter 2 — Qualitative characteristics of useful financial information in response to feedback received on the Exposure Draft Conceptual Framework of financial reporting (‘the Exposure Draft’). The Board discussed the staff analysis and recommendations on this topic.

The staff had prepared the following agenda papers to support this discussion:

1. Agenda Paper 10A Summary of tentative decisions — provided a summary of tentative decisions made so far in the course of deliberations on the Exposure Draft. The summary was provided for information purposes only. See agenda paper for further detailed information.
2. Agenda Paper 10B Chapters 1 and 2 — Introduction provided the background to the discussion and explained why the meeting would focus on the discussion of stewardship, prudence and measurement uncertainty. It also asked the Board to confirm its Exposure Draft proposals on the other topics in Chapter 1 and 2.
3. Agenda Paper 10C Stewardship discussed whether any changes are needed to the discussion of stewardship in response to the feedback received on Chapter 1 of the Exposure Draft.
4. Agenda Paper 10D Prudence discussed whether any changes are needed to the discussion of prudence in Chapter 2 of the Conceptual Framework in response to the feedback received on the Exposure Draft.
5. Agenda Paper 10E Measurement uncertainty discussed whether any changes are needed to the discussion of measurement uncertainty in Chapter 2 of the Conceptual Framework in response to the feedback received on the Exposure Draft.

Conceptual Framework- Chapters 1 and 2—Introduction- Agenda paper 10B

Background

The Board confirmed in April 2016 that redeliberations on the Conceptual Framework project will focus on areas that have been controversial or those where new information has become available. The staff also indicated that the analysis of comments was prepared with consideration of (i) the Board’s intention not to reconsider fundamentally these chapters because they were completed only recently and had been through extensive due process; (ii) the overall objective of the Conceptual Framework project, which is to improve financial reporting by providing a more complete, clear and updated set of concepts instead of fundamentally reconsidering all aspects of the Conceptual Framework; and (iii) the fact that these chapters were developed jointly with the FASB. Any decisions to change them would lead to a non-converged result.

Staff analysis

The staff considered that in respect to Chapter 1 and 2, additional analysis is needed in the following areas: (i) whether to confirm giving more prominence to stewardship as part of the objective of financial reporting; (ii) whether to discuss ‘decision usefulness’ as a broader concept; (iii) whether to confirm the proposed reintroduction in the Conceptual Framework of the notion of prudence; (iv) whether to acknowledge that asymmetry in recognition and/or measurement has a role to play in standard-setting; and (v) whether to confirm the discussion of measurement uncertainty as a factor that affects the qualitative characteristic of relevance, or discuss measurement uncertainty as a factor that affects the qualitative characteristic of faithful representation; and whether to discuss other types of uncertainty.

The staff indicated that the majority of respondents expressed the following: (i) retaining the existing description of the primary user group—ie existing and potential investors, lenders and other creditors; (ii) confirming that the Conceptual Framework should include an explicit statement that a faithful representation represents the substance of an economic phenomenon instead of merely representing its legal form.; and (iii) confirming that relevance and faithful representation should continue to be identified as the two fundamental qualitative characteristics of useful financial information.

Staff recommendations

The staff recommende the following:

1. Retain the existing description of the primary user group in Chapter 1.
2. Confirm that an explicit statement that a faithful representation represents the substance of an economic phenomenon instead of merely representing its legal form should be included in the Conceptual Framework.
3. Confirm that relevance and faithful representation should continue to be identified as the two fundamental qualitative characteristics of useful financial information.

Decision

All the Board members approved the staff recommendations.

Discussion

There was general agreement with the staff recommendations. The main comments were about improving the wording in relation to the discussion of substance over form.  The wording needs to capture the idea that in some cases legal form and substance are different whereas in some cases the legal form determines the substance of the transaction.  A Board member also asked the staff to consider what might be the best location in the Framework for this discussion.

Conceptual Framework- Stewardship- Agenda paper 10C

Background

The purpose of this paper was to discuss the feedback received on the concept of Stewardship. The agenda paper also discusses the staff analysis and recommendations. The Exposure Draft proposed to identify the information needed to assess the stewardship of management as separate from the information needed to help users assess the prospects for future net cash inflows to the entity.

Analysis of feedback received

The staff indicated that many respondents support the Board’s proposal to give more prominence, within the objective of financial reporting, to the importance of providing information needed to assess management’s stewardship of the entity’s resources. Some of the reasons provided were: (i) it acknowledges management’s fiduciary responsibility for the effective and efficient use of the entity’s resources; (ii) because stewardship requires accountability to investors, it influences behavioural changes in decision-making, positively affecting an entity’s long-term performance and success; and (iii) stewardship is an important objective, which management and preparers should consider when making estimates and judgements in financial statements. On the other hand, some respondents disagreed with the Board’s proposal. Some of the reasons provided were: (i) the assessment of management’s stewardship is not the primary focus of all user groups; it may be more relevant to owners than to other primary users; (ii) the term ‘stewardship’ is interpreted differently by different parties; and (iii) financial statements cannot provide all information needed for assessment of management’s stewardship.

Staff analysis

The staff had identified three possible approaches to address the responses received:

• Approach A: No change from the Exposure Draft. The staff indicates this approach provides the following advantages: (i) the Exposure Draft proposal clarifies that information needed to assess management’s stewardship and the prospects of future cash flows are not necessarily the same and thus both needs will be considered when developing new IFRS Standards; and (ii) the proposal was largely supported by the respondents to the Exposure Draft as noted in paragraph 9.
• Approach B: Modifying the objective of financial reporting to explicitly refer to the assessment of stewardship. The staff indicates that this approach will reflect the views of some respondents. However, there are some disadvantages such as: (i) it identifies assessment of stewardship as separate from resource allocation; and (ii) it may imply that financial reports should try to separate the effects of management’s performance from those that are beyond management’s control.
• Approach C: A broader explanation of resource allocation decisions. The staff explains that under this approach, the Conceptual Framework will explicitly identify decisions made while holding investments, i.e. exercising rights attached to the investments, as part of resource allocation decisions. The staff indicates that this approach will help to explain that assessing stewardship is not an end in itself; and will respond to respondents concerns.

In relation to the meaning of the term “stewardship”, the staff noted that there were a variety of interpretations. Accordingly, the staff thought that it would be helpful to explain the Board’s understanding of the notion of stewardship and what information could be needed to assess stewardship.

The staff also considered that it would be helpful to indicate that there is no significant difference between the terms ‘stewardship’ and ‘accountability’ when using them in the context of the Conceptual Framework.

The staff also noted that some respondents expressed concern that different information may be required for assessing management’s stewardship than for assessing future cash flows of the entity. The staff believed that there is a significant overlap in information needed for both assessments for the following reasons (i) both assessments require information about past performance; and (ii) both assessments are influenced by future expectations. On the other hand, respondents had different views on the link between measurement bases and stewardship. Some respondents expressed the view that historical cost measures provide more useful information for stewardship purposes as they are more verifiable. Others argued that in some cases fair value measures may be more useful for assessing stewardship by management. To avoid misunderstandings, the staff proposed that the Basis for Conclusions on the revised Conceptual Framework should indicate that giving more prominence to stewardship does not imply a preference for any particular measurement basis.

Staff recommendations

The staff recommended approach C with the addition of further proposals detailed above.

The staff recommended the following:

1. (Question 1) clarifying the link between the objective of financial reporting and stewardship by explaining resource allocation decisions as: (i) decisions to buy, sell or hold equity and debt instruments; (ii) decisions to provide or settle loans and other forms of credit; and (iii) decisions needed to exercise other rights while holding investments, such as rights to vote on or otherwise influence management’s actions;
2. (Question 2) modifying paragraphs 1.22–1.23 of the Exposure Draft to explain which aspects of management’s stewardship responsibilities can be assessed using information in financial reports;
3. (Question 3) continuing using the term ‘stewardship’ in the Conceptual Framework and indicating that there is no significant difference in the terms ‘stewardship’ and ‘accountability’ in the context of the Conceptual Framework; and
4. (Question 4) indicating in the Basis for Conclusions on the revised Conceptual Framework that: (i) increasing the prominence of stewardship within the objective of financial reporting does not imply a preference for either a historical cost or a fair value measurement basis; and (ii) if, when developing an IFRS Standard, the Board faces a situation when different information is required for the assessment of future cash flows and for the assessment of management’s stewardship, it will have to exercise judgement to seek the information set that is intended to meet the needs of the maximum number of users in cost-beneficial ways.

Decisions

The majority of Board members approved the staff recommendations (approach C) with 12 votes. There will be some changes in the wording as suggested by the Chairman.  

The Board rejected the staff recommendation for modifying paragraph 1.22-1.23 of the ED and the paragraphs will remained unchanged.  

The Board approved using the word stewardship with the inclusion of its definition and rejected the staff proposal to indicate that stewardship and accountability were related terms.  

In relation to the fourth question, the Board approved a modified version of the staff approach which will state that increasing the prominence of stewardship does not imply a preference for historical cost, and rejected the proposed wording.   

Discussion

The discussion was held separately for each of the questions presented in the agenda paper.

The Board was first asked whether they agreed with approach C.  Board members expressed support for that approach, subject to the following comments:

(i) There were concerns about linking stewardship with decisions to buy/hold/sell; the concern was that potential investors were also important; the Chairman responded that potential investors do not vote; also that the concept was beyond buying or selling; it was based on having an active relationship with management;

(ii) There were concerns about the lack of clarity of item c (which referred to other rights other rights while holding investments, such as rights to vote on or otherwise influence management’s actions); some Board members indicated that the concept was not clear;

(iii) The Chairman indicated that he supported the staff recommendation; however he had concern about using the term stewardship which was difficult to translate; he said that in other languages there were no single word to translate this term; also he said that it should use the meaning of the word in English language which was in relation to careful management of resources that are entrusted to management;

(iv) Another concern was that potential investors were also interested in stewardship and the wording of approach C could be misinterpreted.

The next question was whether the Board agreed with modifying paragraphs 1.22–1.23 of the ED.  That question drew the following comments:

(i) There were concerns about discussing corporate strategy and whether that could be interpreted as suggesting that IFRS would require disclosures in this area.  The Chairman cautioned about where this could lead.  He was concerned that, for example, it could lead to disclosures about sustainability reporting.  The staff clarified that their intention was to focus on the financial consequences of the entity’s strategy.

(ii) There were concerns that the wording would imply requiring forward looking information which was not the objective of financial reporting;

The Chairman concluded that there were too many concerns and it would be best to leave the wording unchanged from the ED.

The third question asked of the Board was about continuing to use the term ‘stewardship’ and indicating that there is no significant difference between that term and ‘accountability’. There was disagreement in considering the concepts of stewardship and accountability as being closely linked. The Chairman said that stewardship meant that management have to be accountable.  He said he would prefer improving the definition of stewardship. The Chairman concluded that it would be better to explain the word stewardship without mentioning any relationship with accountability. It was recommended that this should be explained in the Basis for Conclusion. He called a vote and 13 Board members approved his approach.

The fourth issue was a proposal that the Framework state that the increasing prominence of stewardship within the objective of financial reporting does not imply a preference for either a historical cost or a fair value measurement basis.  And if, when developing a Standard, the Board faces a situation when different information is required for the assessment of future cash flows and for the assessment of management’s stewardship, it will have to exercise judgement to seek the information set that is intended to meet the needs of the maximum number of users in cost-beneficial ways).  This discussion drew the following comments:

(i) The staff clarified that the issued was raised by a significant number of respondents.

(ii) There was disagreement expressed by some Board members about having this discussion in the Conceptual Framework.

(iii) Some Board members (including the Chairman) perceived that there was a need to add this clarification because it would take away existing concerns. 

(iv) It would be important to clarify the reasons why the concept of stewardship was included in the Conceptual Framework.

(v) The proposed wording was difficult to understand.

One Board member suggested including a statement that would say that increasing prominence of stewardship does not imply a preference for historical cost; and to reject the proposed paragraph b). The Chairman agreed with this suggestion and 12 Board member approved this approach.

Conceptual Framework- Prudence- Agenda paper 10D

Background

The staff indicated that many respondents to the Discussion Paper urged the Board to reinstate prudence. In response to this feedback, in the Exposure Draft, the Board proposed to reintroduce an explicit reference to the notion of prudence (described as caution when making judgements under conditions of uncertainty). In the Basis for Conclusions, the Board distinguished between two types of prudence: (a) ‘cautious prudence’—a need to be cautious when making judgements under conditions of uncertainty, but without needing to be more cautious in judgements relating to gains and assets than those relating to losses and liabilities; and b) ‘asymmetric prudence’—a need for systematic asymmetry: losses are recognised at an earlier stage than gains are. The Exposure Draft did not identify asymmetric prudence as a necessary characteristic of useful financial information.

The purpose of this session was to discuss the feedback received; the staff analysis and the staff recommendations.

Feedback received

The staff indicated that many respondents support the notion of cautious prudence. However, some respondents agreed that cautious prudence is important for the application of neutral accounting policies; however, they said the Board should also explain how prudence should be applied in the selection of accounting policies. The staff also noted that there are mixed views on who could choose asymmetric accounting policies. The following approaches were suggested by those who support asymmetric accounting: (i) asymmetric prudence that would require more persuasive evidence to support the recognition of gains (or assets) than of losses (or liabilities); asymmetric prudence that would require the selection of measurement bases that include losses at an earlier stage than gains (ie historical cost); (iii) using the pre-2010 version of prudence, that some believe required asymmetry and gave prudence the same prominence as neutrality; and (iv) introduction of asymmetric prudence for the Board in addition to cautious prudence for preparers.

The staff noted that the respondents’ views on the interaction between prudence and neutrality differed. Some respondents, mostly those who supported the reintroduction of prudence as proposed in the Exposure Draft, agreed with the statement that prudence is important in achieving neutrality.

Staff analysis

The staff explored in the agenda paper the following approaches:

1. Not reintroducing prudence in any form. The staff indicated that the 2010 decision to remove the reference to prudence has clearly generated significant debate.
2. Not using the term ‘prudence’: The staff considerd that a newly chosen term, for example ‘caution’, may lead to similar misinterpretations as those expressed in the feedback received.
3. The staff believed that the Conceptual Framework should continue to exclude asymmetric prudence—i.e. a systematic need for asymmetry in recognition/measurement—because: (i) a systematic requirement for asymmetry could sometimes conflict with the need for financial information to be relevant and to provide a faithful representation; and (ii) It could be misinterpreted by some as an opportunity to introduce bias. However, the staff supports including an acknowledgement in the Basis for Conclusions about the possibility of selecting accounting policies that treat gains and losses asymmetrically. The staff thinks that this approach will be helpful because it will clarify that such policies have to result in relevant information that faithfully represents what it purports to represent.
4. The staff noted that the staff discussed in April 2016 the issue of prudence in the Conceptual Framework vs requirements in Standards. The Board confirmed that if a transaction or event is covered by an existing Standard, preparers will not be able to override the requirements of that Standard. This is because the Conceptual Framework itself does not override any of the requirements in the Standards.

Staff recommendations

The staff recommended the following:

1. confirming that the revised Conceptual Framework should include a reference to prudence described as the exercise of caution when making judgements under conditions of uncertainty, as proposed in the Exposure Draft;
2. including in the Conceptual Framework an acknowledgement that accounting policies that treat gains (or assets) and losses (or liabilities) asymmetrically could be selected if their selection is intended to result in relevant information that faithfully represents what it purports to represent;
3. explaining in the Basis for Conclusions on the revised Conceptual Framework that the notion of prudence cannot be used by preparers to override the requirements in IFRS Standards.

Decision

All Board members approved the first proposal (a).  

The Board did not reach an agreement on the second question (b) and asked the staff to bring back the topic for further discussion.

The Board rejected the third proposal (c).   

Discussion

There were no comments raised in relation to the first recommendation.   

In relation to the second issue, significant concerns were raised. There was general disagreement with discussing prudence with asymmetric accounting policies. Another concern was that it could be interpreted that entities could choose asymmetric accounting policies whereas the definition was meant for the Board.

The staff noted that the intention of the proposal was to acknowledge that the Standards already have asymmetric treatment. Furthermore, the staff noted that neutrality did not mean always symmetric accounting policies. The staff view is that neutrality means making decisions in an objective way. The staff said that selecting what information was relevant had to be neutral.

Another concern was whether by linking prudence with asymmetry it would imply that the Board would make more asymmetric decisions.  

One Board member suggested explaining in the Basis for Conclusion that the Board considered and rejected the notion of asymmetric prudence.  Also, the notion of cautions prudence does not prevent the Board from making asymmetric decisions.

The Chairman concluded that there were significant concerns with the wording and the staff should bring back the proposal for further discussion at future meetings.

There were no comments in relation to the third question. The Board rejected the staff proposal.

Conceptual Framework- Measurement uncertainty- Agenda paper 10E

Background

The Exposure Draft proposed that measurement uncertainty is one factor that can make financial information less relevant, and that there is a trade-off between the level of measurement uncertainty and other factors that make information relevant. The purpose of this session was to discuss the feedback received; the staff analysis and the staff recommendations.

Feedback received

The staff indicated that the majority of respondents support the Board’s proposal. However, there were different views expressed as to how measurement uncertainty affects relevance. Some respondents argued that measurement uncertainty is a factor that affects both relevance and faithful representation. Also, some respondents, suggested that measurement uncertainty should be discussed as a factor affecting reliability.

The staff also noted that some respondents explicitly supported the proposal that there is a trade-off between measurement uncertainty and other factors affecting relevance. A few respondents asked for more guidance on the trade-off, including guidance on other factors that affect relevance.

Staff analysis

The staff proposed to discuss the following:

1. If the Conceptual Framework should continue to discuss measurement uncertainty as an aspect of relevance. The staff agrees with the respondents’ argument that the discussion of measurement uncertainty within relevance can be interpreted as conflating usefulness and relevance. The staff thinks that measurement uncertainty by itself is insufficient to affect the relevance of a specific measure. The staff thinks that the existence of uncertainty and outcome uncertainty, or their combination with measurement uncertainty could make an inclusion of a particular information in financial reports lack relevance. The staff believes that in most cases it is possible to provide a faithful representation of a measure that was identified as relevant by selecting and applying an appropriate estimation method and disclosing the related uncertainty. However, the staff thinks that the level of measurement uncertainty can affect whether it is possible to provide a sufficiently faithful representation of a measure in question. The staff recommends moving the discussion of measurement uncertainty to the section describing the qualitative characteristic of faithful representation. This would help to clarify why: (a) a high level of measurement uncertainty does not prevent the use of an estimate if that estimate provides the most relevant information; but (b) a less relevant type of information may have to be provided if there is no measure that would faithfully represent the most relevant type of information.
2. How a related trade-off should be described. The staff thinks that measurement uncertainty does not directly affect the relevance of information. The staff does not recommend that the Conceptual Framework discuss a trade-off between the level of measurement uncertainty and other factors that make information relevant. However, the staff thinks that the Basis for Conclusions should clarify that a trade-off similar to the pre-2010 trade-off between relevance and reliability still exists between the two qualitative characteristics of useful financial information identified in the existing Chapter 2 – relevance and faithful representation. The staff believes that it will help to explain that: (a) both relevance and faithful representation are needed to provide useful financial information; and (b) neither a faithful representation of an irrelevant phenomenon nor an unfaithful representation of a relevant phenomenon helps users make good decisions.
3. If there is a need to discuss uncertainty more broadly (i.e. not just measurement uncertainty) in Chapter 2. The staff noted that the ED did not include a central discussion of uncertainty. However, it referred to different types of uncertainty throughout the document. For example, (i) Chapter 2 discussed how measurement uncertainty affects the relevance of an estimate; (ii) Chapter 5 discussed the effect of existence uncertainty and measurement uncertainty on recognition of elements; and (iii) Chapter 6 discussed the role of outcome uncertainty and measurement uncertainty in decisions about measurement. The staff thinks that it would be helpful to discuss different types of uncertainty in Chapter 2. The staff believes that this will help to (i) put into context the discussion of the qualitative characteristics of useful financial information; and (ii) the document would be easier to read if all types of uncertainty were identified at the beginning of Chapter 2

Staff recommendations

The staff recommended the following:

1. (Question 1) describing measurement uncertainty as a factor affecting faithful representation rather than relevance;
2. (Question 2) clarifying in the Basis for Conclusions on the revised Conceptual Framework that a trade-off exists between the fundamental qualitative characteristics of relevance and faithful representation; and
3. (Question 3) including a brief explanation of existence, outcome and measurement uncertainty in the Introduction to Chapter 2.

Decisions

The Board approved the first proposal by 13 to 1.

The Board approved the second recommendation by 10 to 4. 

The Board approved the wording of the concept stated in the third proposal.  However, the location of the wording has yet to be determined.    

Discussion

No significant comment or concerns were raised in relation to the first issue. 

In relation to the second issue, there were concerns about using the term trade off. It was suggested that this could imply systematic conflict between the qualitative characteristics.  Some Board members could not envisage there being possible implications other than a trade-off. The staff indicated that judgement and balancing did not preclude selecting a particular measurement basis. The staff had intended that it would make the Board focus on what was the most relevant; then the Board would consider whether measurement uncertainty led to it no longer being representationally faithful.  Another concern was that the process to make a decision was just that, a process.  It was not, as the Board were interpreting the words, a simultaneous decision.  The Chairman called a vote and 10 Board members approved the staff recommendation.

In relation to the third issue the following comments were raised: (i) there were concerns about the need to clarify the meaning of outcome uncertainty; one Board member believed that existence and measurement created uncertainty in the outcome; while the staff believed that there could be measurement certainty and outcome uncertainty (i.e. measurement of an equity investment using an observable market price while the final outcome of the investment would be uncertain); (ii) the staff also noted that outcome uncertainty was also dependent on the characteristic of the item being measured;  (iii) other concerns related to the relevance of including these concepts in Chapter 2; in that regard the staff agreed to have the Board vote on the wording and then it would be decided at a future meeting the location of the concept. The Board members approved the revised staff recommendation.