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This paper – on the implications for standard setting of the academic literature review – is based on the premise that financial statements should address the needs of capital provides, while simultaneously considering the costs to preparers. With this starting point the paper infers some implications for standard setting from the academic literature review published by EFRAG and ICAS. To summarise, the main findings are:
(a) Evidence is scarce on how information in financial statements is used – particularly by some groups of users. Given the lack of evidence on how financial statement information is used, standards would to some extent have to be based on assumptions and beliefs about what is useful information.
(b) Although some information is useful for both valuation and the assessment of stewardship, there are areas where the two objectives do not coincide. When preparing guidance, standard setters may therefore in some situations have to prioritise between information that is most useful for predicting future cash flows and information that is most useful for assessing stewardship. Alternatively, standard setters could choose only to provide very general requirements that are useful for both objectives.
(c) Capital providers have diverse information needs. It will not be possible to meet the needs of all types of users simultaneously. Accordingly, standard setters may have to decide how to balance these interests or decide to focus on a specific subset of users when developing new standards. This could be done at a framework level or on a standard-by-standard basis. Alternatively, standard setters could choose to address only general needs of users and allow preparers to provide additional information tailored to those specific groups of users that are considered most relevant in the particular circumstances.
(d) Professional equity investors often base predictions of future cash flows on information in the statement of profit or loss rather than information in the statement of financial position. This could either indicate that the content of the statement of financial position is currently not adequate for predicting future cash flows, or it could indicate that users generally consider information about past performance to be better for predicting future cash flows than information about an entity’s resources and claims. As the latter might be the case, standard setters may choose to pay attention to the effects on the statement of profit or loss, including its ability to be used for prediction of future cash flows, when setting standards.
(e) Some groups of capital providers, such as professional equity investors and debt providers, tend to prefer information reflecting ‘persistent’ or ‘recurring’ earnings. The academic literature review does not provide evidence on whether these users prefer to remove non-recurring items from the ‘bottom line’ themselves or want the management of an entity to do this, for example, by introducing a subtotal for ‘recurring’ earnings. If requirements to present subtotals for ’recurring’ earnings are not introduced, standard setters could consider that users should be provided with information to assess ‘recurring’ earnings. While professional equity investors may want information about recurring earnings, standard setters may, however, also bear in mind that one study suggests that professional analysts may be misled by pro-forma earnings where ‘one-off’ items are typically excluded.