Speech by Hans Hoogervorst on the concept of prudence

  • Hans Hoogervorst (50x80) Image

18 Sep 2012

On 18 September 2012, the IASB Chairman Hans Hoogervorst addressed the Federation of European Accountants (FEE) Conference on Corporate Reporting of the Future in Brussels, Belgium. His speech entitled 'The Concept of Prudence: dead or alive?' discussed the use of judgment in financial reporting and how increased objectivity (while still exercising caution) has improved accounting standards since the Concept of Prudence was removed from the Conceptual Framework.

The IASB Chairman started his speech by discussing the future of corporate reporting, which he sees as integrated reporting — the inter-dependent topics of sustainability, the environment, social issues, and financial reporting. He talked about resolving issues within financial reporting during the next phase of the revision of the IASB's Conceptual Framework.

Mr Hoogervorst went on to note that financial reporting is far from an exact science and is highly dependent on judgement. He provided the definition of Prudence from the previous version of the Conceptual Framework (which was a characteristic of Reliability which is now called Faithful Representation):

The Framework said that Prudence was the inclusion of a degree of caution in the exercise of the judgements needed in making the estimates required under conditions of uncertainty, such that assets or income are not overstated and liabilities or expenses are not understated.

Mr. Hoogervorst noted that there is nothing wrong with this definition, but cautioned against the use of excessive conservatism, noting two problems:

  • During an economic upturn, profits are artificially depressed and investors might miss out on a good investment opportunity.
  • During an economic downturn, hidden reserves can be used to artificially increase an entity's earnings. Profits are overstated, masking the deterioration of the entity's performance.

He stated that the Concept of Prudence was removed when talks began with the FASB on convergence, because US GAAP did not have a definition of prudence. The IASB also felt that the idea "if in doubt, be cautious" was still engrained in its standards and that the neutrality of financial reporting was stressed by leaving out the definition of prudence.

Keeping prudence in mind, Mr Hoogervorst said, there is room for further improvement to IFRSs. He noted several specific issues, but admitted that there were no simple solutions to the problems. He discussed several ways the IASB was working to build sufficient caution into its standards.

Mr. Hoogervorst wrapped up his speech by reiterating his opinion that IASB standards must result in information that is as neutral as possible. He noted that the exercise of caution is visible in many of the IASB's standards and remains a critical issue in the development of new standards. He concluded that the Concept of Prudence is "not dead, but alive and kicking indeed".

Please click for the full text of the speech on the IASB's website.

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