BDO International | IASB: ED: An improved Conceptual Framework for Financial Reporting: Chapter 1 The Objective of Financial Reporting and Chapter 2 Qualitative Characteristics and Constraints of Decision-useful Financial Reporting Information

IASB: ED: An improved Conceptual Framework for Financial Reporting: Chapter 1 The Objective of Financial Reporting and Chapter 2 Qualitative Characteristics and Constraints of Decision-useful Financial Reporting Information

This Comment Letter was sent by BDO Global Coordination B.V., on behalf of BDO International, to the International Accounting Standards Board in September, 2008:

Dear Sir,

An improved Conceptual Framework for Financial Reporting:
Chapter 1 The Objective of Financial Reporting and
Chapter 2 Qualitative Characteristics and Constraints of Decision-Useful Financial Reporting Information

We are pleased to have the opportunity to comment on the above Exposure Draft, issued by the International Accounting Standards Board (IASB), on behalf of BDO International¹.

The decision to review the Conceptual Framework is a timely one, and will be worthwhile if it clarifies the principles underlying the standards. Moreover, alignment must be achieved at this stage between the thinking of the two Boards on these fundamental matters, including the identification of any uses of language where misreadings are possible. Care should be taken, though, to avoid the forcing of a diverse range of ideas into a relatively small number of groupings, particularly if this results in terminology which is some distance from “natural language” usage.

Our main suggestions for improvement concern the definitions of users; the distinction between fundamental and enhancing properties; and the order of priority of the qualitative characteristics. We would also question whether too much prominence is given to constraints: this may be better viewed as an issue for standard-setters rather than for preparers, and we believe that the Conceptual Framework should ultimately be a resource designed first for preparers. These views are set out below, with our responses to the Boards’ detailed questions set out in the Appendix to this letter.

User groups

The objective of general purpose financial reporting, in OB2, is set out as being to enable decision-making on behalf of “capital providers”. In a typical use of language, “capital providers” would include only shareholders and lenders, rather than including the much wider group which appeared to have been envisaged in earlier discussion papers on the Framework. It would be a mistake to limit user groups so severely, and this seems to have been addressed in an unconventional way in OB 5-8 by stating that this group includes other stakeholders such as employees.

While we agree entirely with the proposition that individuals such as employees are a key user group to whom general purpose financial reporting should be addressed, the way to achieve this is not by a straining of the phrase “capital providers” but instead by using the term “stakeholders” and explaining who is included in this group.

A consequence of using the much more limited name that is currently proposed is that certain stakeholders who are important, for example governments, have been excluded because there is no way to fit their activities into the definition. Changing the terminology would allow a more comprehensive inclusion of all the parties who have a reason to be interested in general purpose financial reporting, which is a vital part of setting up a stable base.

Decision-usefulness

Once the stakeholders have been better defined, the concept of decision-usefulness is an appropriate and relevant one. We applaud the Boards’ decision to bring the ability to assess the stewardship of directors into decision-usefulness, and concur that it does not need to be a separate goal. A shareholder’s key decision is whether to leave his funds in the company, and one of the factors influencing this will be the information that he has available on how well the directors are looking after that money. It is valuable, though, to have this explicitly expressed within the body of the Framework, as it has been such a crucial concept in many national GAAPs.

Other comments on chapter 1

Our other suggestion for the first chapter is that it should include more guidance on what is meant by “general purpose financial reporting”. Our view is that this framework should be designed for a typical set of financial statements, rather than being of a broad scope which attempts to address all possible types of financial reporting.

OB25 refers to the principal underlying assumptions or estimates. However there is no discussion of the underlying assumptions referred to in the Framework, e.g. going concern. Are these to be the subject to a later chapter?

Qualitative characteristics

When the Exposure Draft moves on, in chapter 2, to qualitative characteristics, more questions arise.

We would urge caution over the extent to which emphasis is given to the predictive value of general purpose financial reporting. While of course in truth many users will use published information to make predictions, this should not be their most important purpose, and preparers should not be encouraged to prioritise this when they report. Reporting should be focussed on the best possible representation of the past: if stakeholders choose to use this to base future plans on, this is unsurprising, but realistically financial reporting cannot, and should not, look forward in time from the balance sheet date, apart from in very particular circumstances, for instance assessment of impairment and going concern.

Fundamental and enhancing

The distinction between fundamental and enhancing characteristics carries some risk. While it is appealing to reduce the number of “must-haves” to two, this would inevitably lead to the other characteristics being seen as “nice to have” or “optional”. To suggest that general purpose financial reporting does not have to be verifiable, or in other words that there does not need to be any way of assessing whether it is true, seems to remove almost entirely the point of publishing general purpose financial reporting. We would propose removing this distinction and allowing all of the properties equal status, perhaps accompanied by some quantity of guidance on prioritising them, rather than having some as optional.

Timeliness

This suggested merging of the categories would not need, however, to include all of the qualities. “Timeliness” for example, is not a true property of general purpose financial reporting. While one must agree that stakeholders prefer to receive financial information rapidly, this is a matter for jurisdiction and does not as such affect the reporting. As a merely incidental property, it should not be prioritised, and would be better excluded completely.

Faithful representation and relevance

More fundamentally, examining the other properties, we feel that a re-ordering of the first two would be more convincing, so that paragraphs QC7-QC11 come before QC 3-6. If the decision process of preparers were geared to assessing first what was relevant and then how to represent it, there would be a danger of incompleteness, as measurement errors might lead to an area appearing immaterial or irrelevant, and therefore being ignored. An entity’s transactions and economic position are a matter of fact, and if these are all faithfully represented, with sufficient reporting accuracy, then a truly informed decision can be made about which aspects are relevant to the user. Accordingly, we propose the re-ordering described above and a redraft of paragraphs QC12-13.

We note the discussion in BC2.19 that “The boards concluded that faithful representation means that financial reporting information represents the substance of an economic phenomenon rather than solely its legal form. …. . Accordingly, the proposed framework does not identify substance over form as a component of faithful representation because to do so would be redundant.” However we did not agree. The list of factors in QC 7 relating to the faithful representation of the economic phenomena should also make reference to substance.

Materiality and cost

Finally, we are concerned about the allowances made for the constraints on financial reporting. As the ED says elsewhere, the conceptual framework sets out an ideal for financial reporting, and this ideal should not have compromises built into it. Just as we objected to the introduction of excessive “undue cost or effort” clauses in the SME ED, we also feel it would be misguided to cloud the goal of financial reporting by stating that it should all be subject to cost constraints. Moreover, materiality is not a constraint: it is part of the process of assessing faithful representation. We would propose, therefore, the removal of paragraph QC33, and the moving of QC32, or an adapted version thereof, into the section on faithful representation in QC7.

With these proposals incorporated, we feel that this draft will provide a sound basis and beginning for a new conceptual framework.

We hope that you will find our comments and observations helpful. If you would like to discuss any of them further, please contact either Helen Thomson at + 32(0)2 778 0134 or Andrew Buchanan at +44 (0)20 7893 3300.

Yours faithfully,

BDO Global Coordination B.V.

Appendix

Responses to specific Questions

Chapter 1: The objective of financial reporting

1.	The boards decided that an entity’s financial reporting should be prepared from the perspective of the entity (entity perspective) rather than the perspective of its owners or a particular class of owners (proprietary perspective). (See paragraphs OB5–OB8 and paragraphs BC1.11–BC1.17.) Do you agree with the boards’ conclusion and the basis for it? If not, why? We concur with the Boards’ proposal that the entity perspective is the most appropriate basis, and is consistent with the core concept of neutrality, ensuring that no user group’s needs are met at the expense of others’.
2.	The boards decided to identify present and potential capital providers as the primary user group for general purpose financial reporting. (See paragraphs OB5–OB8 and paragraphs BC1.18–BC1.24.) Do you agree with the boards’ conclusion and the basis for it? If not, why? We do not believe that “capital providers” as the phrase is normally used covers a sufficiently wide user group. Our comments on this are included in our letter.
3.	The boards decided that the objective should be broad enough to encompass all the decisions that equity investors, lenders and other creditors make in their capacity as capital providers, including resource allocation decisions as well as decisions made to protect and enhance their investments. (See paragraphs OB9–OB12 and paragraphs BC1.24–BC1.30.) Do you agree with that objective and the boards’ basis for it? If not, why? Please provide any alternative objective that you think the boards should consider. We agree that a broad concept of “decision-usefulness” is the most appropriate.

Chapter 2: Qualitative characteristics and constraints of decision-useful financial reporting information

Are the distinctions - fundamental and enhancing qualitative characteristics and pervasive constraints of financial reporting—helpful in understanding how the qualitative characteristics interact and how they are applied in obtaining useful financial reporting information? If not, why?

We do not concur with the use of these distinctions, as set out in our letter.

1.	Do you agree that: (a) relevance and faithful representation are fundamental qualitative characteristics? (See paragraphs QC2–QC15 and BC2.3–BC2.24.) If not, why? We agree that these are crucial characteristics, though would prefer to see them re-ordered as set out in our letter.
	(b) comparability, verifiability, timeliness and understandability are enhancing qualitative characteristics? (See paragraphs QC17–QC35 and BC2.25–BC2.35.) If not, why? Again, we agree that these are valuable properties, though they should not be viewed as “second tier”. Our explanation of this and of why timeliness should be excluded is set out in our letter.
	(c) materiality and cost are pervasive constraints? (See QC29–QC32 and BC2.60–2.66.) If not, why? Is the importance of the pervasive constraints relative to the qualitative characteristics appropriately represented in Chapter 2? We do not agree with the descriptions and inclusion of pervasive constraints in this way: see our letter.
2.	The boards have identified two fundamental qualitative characteristics - relevance and faithful representation: (a) Financial reporting information that has predictive value or confirmatory value is relevant. (b) Financial reporting information that is complete, free from material error and neutral is said to be a faithful representation of an economic phenomenon. (i)Are the fundamental qualitative characteristics appropriately identified and sufficiently defined for them to be consistently understood? If not, why? (ii) Are the components of the fundamental qualitative characteristics appropriately identified and sufficiently defined for them to be consistently understood? If not, why?
3.	Are the enhancing qualitative characteristics (comparability, verifiability, timeliness and understandability) appropriately identified and sufficiently defined for them to be consistently understood and useful? If not, why? The characteristics are well defined, even though we do not agree with the inclusion of all of them. We would also prefer to see a reduction in emphasis on the predictive value of general purpose financial statements.
4.	Are the pervasive constraints (materiality and cost) appropriately identified and sufficiently defined for them to be consistently understood and useful? If not, why? These pervasive constraints are well identified and defined though we disagree with the inclusion of cost and suggest that materiality would be better included as a guiding factor for assessing faithful representation.

¹BDO International is a world wide network of public accounting firms, called BDO Member Firms, serving international clients. Each BDO Member Firm is an independent legal entity in its own country.

The network is coordinated by BDO Global Coordination B.V., incorporated in the Netherlands, with an office in Brussels, Belgium, where the Global Coordination Office is located.

An improved Conceptual Framework for Financial Reporting: Comments due 26 September 2008:

ED An improved Conceptual Framework Chapter 1 and 2.pdf