Conceptual Framework — Agenda paper 10
The IASB continued its discussion of the comments received on the Conceptual Framework exposure draft. The topics for this meeting were:
- The reporting entity (Agenda paper 10B);
- Presentation and disclosure (Agenda paper 10C);
- Asymmetry in treating gains and losses (Agenda paper 10D);
- Definition of equity and supporting discussion (Agenda paper 10E); and
- Materiality (Agenda paper 10F).
In addition, the tentative decisions made to date are summarised in Agenda paper 10A.
The Board also held an educational session in which the staff presented redrafting suggestions for sections of the measurement chapter. The Board was not asked to make decisions on that redrafting. The session overview is Agenda Paper 10I, the factors considered are described in Agenda Paper 10G and the re-drafted sections are in Agenda paper 10H).
The Exposure Draft (ED) of the Conceptual Framework sets out in chapter 3 the discussion about the reporting entity. The main issues are set out below under staff analysis. The agenda paper includes an appendix with other comments received and staff responses.
Description of the reporting entity
The staff noted that a few respondents are concerned that the definition of the reporting entity is too broad. Some respondents also suggested the definition could be improved by adding material from the 2010 ED the Reporting Entity. The staff believes that the Conceptual Framework ED already sets out the features of a reporting entity that are necessary to identify a reporting entity (economic activity are being conducted, those activities can be objectively distinguish, and the financial information about those economic activities has the potential to be useful). The ED also includes the notion that the financial information provided about a reporting entity that is not a legal entity must be useful and the information must be (i) relevant to the users; and (ii) faithfully represent the economic activities of the entity. Accordingly, the staff does not recommend any changes in this topic.
Boundary of the reporting entity
The staff noted that respondents supported the analysis but requested more guidance on how to identify the boundary of the reporting entity for example in cases when a reporting entity is only a portion of the entity or comprises two or more entities that do not have a parent-subsidiary relationship. The staff believes that the Board has already responded those concerns in the ED, particularly when explaining the requirements for a non-legal entity to be considered a reporting entity (see above). The staff also received a request to clarify if carve-out or combined financial statements could be considered IFRS compliant. The staff believes that such analysis is beyond the scope of the ED. Further, the staff believes that such assessment depends on specific facts and circumstances and the concepts of the boundary of the reporting entity could assist in making the judgement.
Direct and indirect control
The staff noted that some respondents thought that the terms direct and indirect control were consistent with IFRS 10 whereas others did not. The staff believes that it is important to retain those concepts because they are consistent with IFRS 10. Nevertheless, the staff believes that the concepts could be better explained in the Basis for Conclusions explaining that those notions do not relate to ‘direct’ vs ‘indirect’ (i.e. via another entity) control over a subsidiary. Instead, they relate to control over economic resources and obligations for the related claims.
Consolidated and unconsolidated financial statements
Some respondents disagreed with the statement that consolidated financial statements are more likely to provide useful financial information than unconsolidated financial statements, because the usefulness of financial statements depends on the user’s needs. The staff believes that the ED states that consolidated financial statements are generally more likely to provide useful information and thinks that this statement establishes the principle.
Some respondents disagreed with the statement that consolidated financial statements are not intended to provide information to users of the subsidiary’s financial statements. The staff disagree.
Concerns were expressed with the statement that unconsolidated financial statements should disclose how users may obtain consolidated financial statements. The staff agrees with this topic because it should be set at a Standard level and recommends deleting this paragraph.
Going concern assumptions
The staff indicates that a few respondents requested more guidance for cases in which an entity is no longer a going concern, also to clarify the terms foreseeable future or different basis of preparation. The staff believes that those areas are beyond the scope of the ED and should be part of a Standard level activity.
The perspective form which financial statements are prepared
Some respondents asked for additional explanation as to why the Board has adopted the entity perspective and not the proprietary perspective. The staff believes that adopting the entity’s perspective is consistent with the fact that the majority of today’s entities are separate and distinct from the capital providers and that the objective of general purpose financial statements is to provide useful information to investors, lenders and creditors instead to a particular class of capital provider. The staff considers that such rationale could be added in the Basis for Conclusions.
The staff recommends confirming the items discussed in this chapter with some minor amendments including: a) clarify the concepts of direct and indirect control in the Basis for Conclusions; and b) delete the statement need to disclose in unconsolidated financial statements how users may obtain its consolidated financial statements (the staff believes that any such requirement should be at Standard level).
Reporting entity (questions 1 and 2)
The Board approved the staff recommendations subject to wording changes in relation to the boundaries in the reporting entity and improving the explanation of completeness.
The discussion was extensive and significant comments were raised. The concerns were focused on: (i) the lack of discussion in the agenda paper about the concept of combined financial statements; and (ii) the wording used by the staff to describe the boundaries of a reporting entity.
In relation to the first issue, the concerns were related to the fact that more work is needed to explain the concept of combined financial statements. It was mentioned that it is necessary to provide a conceptual explanation, describe its objective and clarify when they should be considered general purpose financial statements. Further, it was noted that preparers and auditors need guidance to support the basis that those financial statements comply with IFRS. The staff responded that the ED already explained the notion of financial statements presented by a non-legal entity, the staff noted that those financial statements should provide relevant information and faithfully represent the economic activities of the entity. Some Board members noted that such statement was very high level and did not provide clarity. On the other hand, the staff and some Board members noted that providing more clarity would require additional analysis.
The second concern was focused on the notion of a set of economic activities as the boundary of a reporting entity. Several Board members were concerned for not using the word ‘complete’ set of economic activities. It was pointed out that an entity would be able to pick what to report (i.e. only report profitable stores), and the definition appeared to be circular. The staff responded that the Board had already discussed this concern and decided against using the word complete. Another point noted in support for adding the word complete was that it would help in developing the notion of combined financial statements. The staff noted that the notion was already captured because the ED stated that if economic activities are incomplete, then the financial statements would not provide relevant information. On the other hand, some Board members noted that the word complete (in defining combined financial statements) would move the concept of completeness in a different direction because the key notion was to understand the purpose of the combined financial statements.
Concepts of direct and indirect control (question 3)
The Board did not approve the staff recommendations. Instead, the Board decided that the staff should explore using different language to explain the concepts without using the terms direct and indirect. The staff will retain the basis for consolidated and unconsolidated information.
The majority of the Board members expressed concerns on how the words direct and indirect control were used. This was because it seemed that the Board would create another problem by using a different meaning from the current accepted meaning of those words. Some members noted that the concept could still be explained without using those terms. The notion of adding more explanation in the Basis for Conclusions was rejected.
Consolidated and unconsolidated financial statements (question 4)
The Board approved the staff recommendations subject to wording changes.
During the discussion, several Board members expressed concern with the wording proposed by the staff that in general consolidated financial statements are more likely to provide useful information than separate financial statements. The concern was based on the fact that such statement seemed to imply that individual financial statements do not provide useful information. Also, it was noted that it could imply that the Board was prohibiting users from taking information about subsidiaries from consolidated financial statements. Another issue was that it could restrict future discussion. Some Board members noted that both financial statements had different purposes and each of them are useful, and complement each other.
Going concern (question 5)
The Board approved the staff recommendations. No questions or comments were raised by the Board.
The perspective from which financial statements are prepared (question 6)
The Board approved the staff recommendations subject to minor wording changes.
During the discussion it was pointed out that other perspectives could also be important (i.e. entity’s shareholders) and that fact should be acknowledge in the wording. The staff and other Board members noted that an entity is not prevented from considering other users and providing more information. It was agreed that the wording would acknowledge that an entity is not prevented from adding more information by considering other perspectives.
The Exposure Draft (ED) of the Conceptual Framework sets out in chapter 7 the discussion about presentation and disclosure.
Appendix A of this agenda paper includes other comments and staff responses, and Appendix B provides a high level summary of the ED Chapter 7.
The objective and scope of financial statements:
The staff noted that most respondents agreed with this section of the ED. However, some respondents raised concerns about not having separate objectives for each component of the financial statement. Also some respondents asked the Board to clarify the boundaries between financial statements and other information included in general purpose financial statements. The staff disagrees with those concerns because the staff believes that the objective of each component of financial statements should be set in specific Standards. The staff also believes that the objective of each component should be part of the discussion of the Principles of Disclosures project. In relation to the second concern, the staff believes that by setting the scope of financial statements by reference to their objective is a better indicator to provide the scope boundaries of financial statements.
Components of financial statements
Some respondents asked the Board to identify a set of financial statements and discuss the relationship between those statements and the notes. The staff believes that the Board has already responded to those concerns and Board concluded that this discussion should be part of the Principles of Disclosure project. The staff believes that such a project will suggest the notion of primary financial statements, and will identify the statement of financial position, the statement of financial performance the statement of cash flow and the statement of changes in equity as “primary financial statements”
The statement of cash flows and the statement of changes in equity
Some respondents expressed concern about the potential implication that the statement of cash flow and the statement of changes in equity are not primary financial statements because those statements are not mentioned explicitly in the ED. The staff does not share this concern. They say that the statements referred to in the ED provide a summary of recognised elements (assets, liabilities, income and expense) whereas the statement of cash flow includes items that are not elements (i.e. cash inflows and outflows).
The terms ‘presentation’ and ‘disclosure’
Some respondents expressed concern because the ED does not make a distinction between the terms presentation and disclosure. The staff considers that the Board has already concluded as part of the Disclosure Initiative project that such distinction is not necessary as long as it is clear where information must be displayed.
The staff recommends no changes to the ED in the topics discussed above. Accordingly the staff recommends the Board to: a) confirm that the objective of the financial statements is to provide information about an entity’s assets, liabilities, equity, income and expenses that is useful to users of financial statements; b) describe the objective of the financial statements as a whole rather than its components; c) describe the scope of the financial statements by reference to their objective; d) identify no primary financial statements; e)refer only to the statement of financial position and financial performance; f) make no distinction to the term “present” and “disclose”.
The Board approved the staff recommendations.
The discussion was mostly focused on question 3 which related to the staff recommendation for not making an explicit mention of the Statement of Cash Flows. The concerns noted were that this action could lead to the implication that the Statement of Cash Flows is not important. The staff noted that the objectives of providing information related to cash flows are already mentioned in the ED. On the hand, those members that supported the staff recommendation thought that the Statement of Cash Flows should not be part of the conceptual framework because it should be discussed at a standards level. The interpretation of the objectives set in the Conceptual Framework should be done at a Standard level. Some Board members objected to specific mention of the Statement of Cash Flows because they do not consider it to be useful for some industries.
The Board tentatively decided in May 2016 to confirm its proposal in the ED that the revised Conceptual Framework should include a reference to prudence which should be described as the exercise of caution when making judgements under conditions of uncertainty. The Board also rejected the notion of asymmetric prudence. The ED includes in the Basis for Conclusions the notion of prudence as “cautious prudence”. The Board asked the staff to explore further whether and how the Conceptual Framework should acknowledge the asymmetric treatment of gains and losses.
Staff analysis and recommendation
The staff think that the proposal in the ED already allows income to be treated differently to expenses and assets to be treated differently from liabilities provided that such a decision is based on the usefulness of the resulting information.
Some respondents asked for more visible acknowledgement that it will still be possible to develop financial reporting requirements that treat income and expenses differently. The staff indicates that respondents seemed to associate neutrality with the requirement for symmetry. The staff believes that neutrality refers to impartiality, lack of bias and objectivity. Accordingly, neutrality does not require a uniform, or symmetrical treatment of all economic phenomena.
The staff recommends expanding the description of prudence to clarify that the exercise of prudence does not imply that it is necessary to have different financial reporting requirements for income than expenses and for assets than for liabilities.
The Board did not approve the staff recommendation and the topic will be discussed again at a future meeting. The Board agreed that the staff should draft tentative wording to include in the body of the Framework to acknowledge that the Board could make decisions about asymmetric treatment if appropriate.
The discussion was primarily focused on whether such acknowledgement should be in the body of the Framework or in the basis for conclusions.
Some Board members indicated that they would prefer to have the discussion in the body because it was a key issue raised by respondents. Other members expressed preference for maintaining the discussion in the basis for conclusions because the standard was clear enough. In that regard, one Board member pointed out that it would be difficult to discuss asymmetry without defining this term, he also considered this discussion to be more relevant as part of the measurement chapter.
The ED proposed retaining the existing Conceptual Framework definition of equity and some discussion supporting the definition of a liability. The ED defines equity as the residual interest in the assets of the entity after deducting all its liabilities.
The ED also proposed including some discussion about measuring equity. The ED stated that equity is not measured directly and that equity equals the total of the carrying amount of all recognised assets less the total carrying amount of all recognised liabilities.
Staff analysis and recommendation
Although many respondents agreed with the proposal, others indicated that it is important to complete the work related to the FICE project and some had concerns about the proposed definition of a liability. The staff indicates that this, last, concern will be discussed at a future meeting.
Some respondents would prefer that equity should be defined independently of the definition of assets and liabilities. Some respondents stated that the definition of equity might include some other characteristics including loss absorption, exposure to risks of variable returns; the characteristics of different categories of reserves and ownership.
The staff says that the Board considered a three category approach when developing the ED and concluded that introducing another element would make the classification more complex and simply shift the challenges of the distinction between liabilities and equity from one to the other. The staff believes that the Board had already fully explained this in the Basis for Conclusions. Also, the Board has decided to continue addressing challenges related to the classification of financial instruments with characteristics of both equity and liabilities as part of the FICE project. The staff also believes that the direct measurement of some individual classes of equity would not be inconsistent with the definition of equity as a residual.
The staff recommends maintaining the proposals set out in the ED.
The Board approved the staff recommendation. The discussion was very brief and no significant concerns were raised. Few Board members indicated some concern about measuring equity as a residual or for example measuring certain items of equity directly and others as a residual.
The ED proposed that no amendments be made to the concept of materiality in the Conceptual Framework except to clarify that decisions about materiality reflect the needs of the primary users, not the needs of any other group.
Staff analysis and recommendation
The staff noted that few respondents made comments on this topic. Respondents suggested that after the work on materiality is completed as part of the Disclosure Initiative, the Conceptual Framework should be revised to reflect it.
The staff indicates that the Principles of Disclosure Discussion Paper will suggest a number of changes to the existing definition of materiality in IAS 1 and IAS 8. Their assessment is that the proposed definition in the Principle of Disclosure project is consistent with the ED. However, the discussion paper will suggest clarifying the threshold at which information becomes material by replacing “could influence” with “could reasonably be expected to influence” and including reference to “obscuring” information, not only omitting and misstating it. The staff recommends retaining the definition of materiality proposed in the ED.
This agenda paper was not discussed.
Conceptual Framework — Measurement
The Board instructed the staff in July 2016 to revise the discussion about how selecting a measurement basis might be influenced by the characteristics of an asset or a liability and how the asset or liability contributes to future cash flows.
Many respondents said that the chapter failed to provide adequate guidance for the development of future accounting standards. Also, respondents said that the link between the sections setting out the measurement bases and the information they provide and factors to consider when selecting a measurement basis was not sufficiently clear.
The staff has redrafted Chapter 6 of the ED (see Agenda paper 10H). The purpose of this session is to obtain the initial reaction from the Board on the concepts described in the proposed redraft.
The staff is also seeking input from ASAF members, at their September meeting.
Analysis — Agenda paper 10I
This agenda paper (a PowerPoint presentation) describes how measurement basis is presented in the ED, the tentative Board decisions (see agenda paper 10A) and the main points the staff considered in redrafting the chapter.
The staff has re-drafted the chapter to emphasise the importance of selecting a relevant measurement, which is consistent with the discussion on qualitative characteristics (Paper 10H, paragraph 6.49A). They have also attempted to discuss the contribution to cash flows and the characteristics of asset/liability discussed in terms of relevance.
They have also re-drafted the sections on contributions to future cash flows, building on Chapter 1, and emphasising that some assets/liabilities generate cash flows directly whereas others are used in combination to generate cash flows indirectly. This depends, in part, on the entity’s business activities. The chapter also suggests that current values (fair value, value in use/fulfilment value) are likely to be relevant for assets/liabilities that produce cash flows directly.
The staff suggest specifying the following:
- Liabilities incurred to raise finance are unlikely to be transferred/settled before maturity so cost-based information may be relevant (Paper 10H, paragraph 6.54D)
- Where financial assets held to collect contractual cash flows, cost-based information may be relevant (Paper 10H, paragraph 6.54E)
- For some inventory (other than commodity-type inventory), cost-based information may be relevant (Paper 10H, paragraph 6.54F)
- For liabilities for performance obligations to customers cost-based information may be relevant (Paper 10H, paragraph 6.54G)
- Where cash flows or value is variable or sensitive to market values or other risks, a current value such as fair value or value in use is likely to be relevant
- Where cash flows are variable—not simply principal and interest—amortised cost cannot be used
- Where value is sensitive, current value is relevant in assessing features identified as being of interest to users in Chapter 1 –and historical cost might not produce appropriate income and expenses.
Redrafting the factors to consider in selecting a measurement basis — Agenda paper 10G
The staff indicates that, based on the comments received, the changes are mostly required in (i) the contribution of the asset to future cash flows (see agenda paper 10H- paragraphs 6.54A-6.54G); and (ii) the characteristics of the asset (see Agenda paper 10H- paragraphs 6.54H-6.54K).
The staff rejected having a detailed prescription of factors, because their relative importance depends on specific circumstances.
There was general support for the direction of the topic presented by the staff. However, during the discussion there were some conflicting views expressed by the Board. Some Board members indicated that the proposed draft was too lengthy and prescriptive while others indicated that more guidance was needed for particular cases not considered by the staff. Those who thought it was too prescriptive said it looked more like a Standard than a guide for future standard setting. They also thought there was too much detail and the staff should avoid presenting a rigid hierarchy. Board members emphasised that the staff should not try to address in the proposed draft every comment received.
Following the debate, it was agreed that the staff should continue with the approach proposed while at the same time reducing the number of examples in the draft. The staff was also asked to focus more on the benefits and weaknesses of each measurement basis instead of providing examples.
The staff clarified during the discussion that the draft did not consider situations when more than one measurement basis would be appropriate and that topic would be addressed separately.
The Chairman noted that the wording presented by the staff was flexible and was a big improvement. He was expressly against going back to the original ED in which there was no discussion on measurement bases.