12 September 2013

EFRAG/National Standard-Setters publish two new Bulletins in relation to the review of the IFRS Conceptual Framework

Accountability and the objective of financial reporting. This Bulletin discusses whether financial statements should provide information that is useful for an assessment of management’s accountability (or stewardship) and whether this objective is adequately reflected in the IASB’s Conceptual Framework.

One of the main arguments for providing information on accountability is that it enables investors to oversee management behaviour. Although management are appointed by the shareholders, the interests of management and shareholders may diverge. For example, management may have an incentive to undertake risky investments where their entitlement to bonus payments is linked to profits but they do not share in any losses. Or management may prefer to avoid the work that would be required by restructuring the business. Financial statements that fulfil an accountability objective can assist shareholders in detecting where the business is not being managed in accordance with their objectives.

If financial statements reflect an accountability objective they may control management as well as reporting on them. Because management are aware that they must provide an account of their actions, they are less likely to undertake sub-optimal business strategies or fail to exercise proper diligence, as it will incur the risk that such actions will be detected.

Accountability can therefore reduce the risk of investment and so make it more attractive.

Shareholders are not always able to sell their shares (for example, where the shares are unlisted) or may not wish to do so (for example, where exposure to a particular sector is required to balance their portfolio, or they take the view that long-term prospects for the company are not fully reflected in the current share price). They therefore seek to influence the company’s future business strategy and actions: to do so they need information on the development and performance of the company’s business, and information that assists them in understanding the prospects for alternative strategies.

Moreover, an accountability objective serves management as well as shareholders. Both parties want the relationship of principal and agent to work. It will not do so in the absence of trust. Financial statements that fulfil an accountability objective assist them in building that trust.

Hans Hoogervorst noted that a close reading of the existing Framework would confirm that the principle of accountability is there, but conceded that “I can imagine that some might find the essence of the stewardship principle a bit hard to find”.

This is worrying. In the development of accounting standards, the Framework is inevitably abridged and summarised. If it contains a concise objective of decision-usefulness, that objective will set the focus of the debate, and an explanation a page or two later that decision-usefulness encompasses accountability will be overlooked.

Some may take the view that the reference to the essential ideas of accountability in the existing Framework is adequate. However, it may be noted that, as described in the Framework, the relevance of information on accountability is limited to that which assists in assessing future cash flows and in taking decisions, such as voting in company meetings.

It may be questioned whether it is appropriate to limit accountability in this way.

The partners have, on balance, reached the following tentative views:

• The ASCG and the OIC believe that the IASB adequately addressed the importance and the role of accountability/stewardship in its 2010 Framework;

• The ANC believes that the provision of information on accountability/stewardship is the primary objective of financial reporting; and

• EFRAG and the FRC believe the provision of information on accountability/stewardship is a primary objective of financial reporting, not merely a part of or ancillary to another objective, and should be reinstated as such.

The asset/liability approach. This Bulletin considers whether the approach adopted in the Conceptual Framework of defining equity, income and expenses on the basis of the definitions of assets and liabilities is satisfactory, and in particular whether it:

• implies that the presentation of information on income will be subordinated to information on assets and liabilities;
• provides an appropriate basis for reporting performance;
• requires that all assets and liabilities are recognised; and/or
• implies that all assets and liabilities are to be stated at fair value.

EFRAG and national setters support the IASB’s conclusion that “No primary financial statement has primacy over the other primary statements and they should be looked at as a group”. A consequence of this is that the effect on income of proposed accounting treatments should be fully addressed in the development of standards.

Many of the issues raised by those who have reservations about the asset/liability approach are valid. The Framework should provide satisfactory principles for the reporting of financial performance: that assets and liabilities are not recognised where the benefits of doing so outweigh the costs, and that assets and liabilities are stated at fair value only if it is appropriate. EFRAG and national setters will continue to seek to influence the development of the Framework to ensure that its treatment of these issues is satisfactory. It is particularly important that the representation of performance should not be obscured by changes in asset and liability values that are not part of performance: the implications for reported performance should be explicitly addressed in the development of all proposed accounting treatments. EFRAG, the ASCG, the OIC and the FRC do not think that the asset/liability approach— defining income and expenses in terms of changes in assets and liabilities—in itself prevents satisfactory approaches to these issues being developed. Also, in many cases, it seems to provide greater clarity for the development of accounting standards. The ANC does not share this view and considers that concerns and arguments developed in many parts of this Bulletin (paragraphs 5, 6, second part of 8, 12, 13, 23, second part of 24 and first part of 28) are important enough to call for a different approach: indeed performance cannot be appropriately represented in the accounts if primacy continues to be given to the balance sheet.

Press release

Bulletin - Accountability and the objective of financial reporting

Bulletin - The asset/liability approach

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