Commentary on Siena Open Forum: Conceptual Framework

Professors Gebhardt and Dean led an Open Forum discussion about general conceptual framework matters as part of the Siena EIASM Fourth Workshop on Accounting Regulation. This forum session augmented discussions related to the Fair Value Measurement papers presented at the Siena Workshop the previous day.

This Open Forum on the Conceptual Framework occurred at a critical stage, as informed debates about the convergence of the IASB and FASB CFs may influence likely outcomes. The topicality of the measurement and related deliberations is evidenced by the number and significance of other similar high profile international journal forums proposed. Indeed the European Accounting Review has sponsored an entire special issue on Fair Value Measurement which is expected to be published some time in 2009 and which should coincide with the issuance by the IASB of an Exposure Draft on Fair Value Measurement.

Approximately seventy-five attendees at the Siena Open Forum generated lively discussions, and what follows is a commentary on them.

Günther Gebhardt chaired the session. Opening the proceedings he summarized the current position of the CF project (see Table 1 in Whittington, 2008). He pointed out that when both the FASB and the IASC started issuing standards on specific accounting problems they inevitably identified the need to develop a common framework of objectives, principles and definitions as a guideline for the future development of a consistent set of accounting regulations. The FASB issued a series of seven Concepts Statements (SFAC) from 1978 to 2000 while the IASC, drawing on the FASB work, issued its much shorter Framework document in 1989.

Since then both boards have issued new or revised standards which are not always consistent across and within both CFs. One reason is that neither the SFACs nor the ISAC Framework is sufficiently specific (or well developed) to allow accounting rules to be derived directly. A major deficiency is that the CFs have not settled on a capital maintenance concept. Another problem is the minor significance attributed currently to the CFs in the U.S. GAAP and the IAS/IFRS hierarchies, where standards are given clear priority over concepts.

The extant CFs are similar, but not identical, and in 2004 as a cornerstone of the convergence agenda both Boards decided to work on forging a new common CF. The goals of this CF project are limited as the Boards started from the premise that only some refinement, completion and updating is needed—they expect more changes in language than in substance. Failure to undertake a fundamental review has proven already to have been an opportunity lost.

The chair continued, noting that a major issue to be discussed is whether changes in wording in the proposed framework will also be perceived as leading to differences in substance. Also, he observed that the issues to be considered in the joint FASB/IASB CF project have been thoroughly discussed in the accounting literature in many countries, not only in the Anglo-American sphere (especially in the 1950s and 1960s, the so-called Golden Age of normative research), but also in continental Europe with its long tradition of normative accounting research.

As such, academics have an important role in ongoing CF deliberations to bring to the attention of standard setters that literature and its implications. As an example, the European Accounting Association Financial Reporting Standards Committee (EAA FRSC) had been formed to assist the standard setters by gathering and summarizing the results from extant research and discussions in the different national environments. This is to be undertaken in comment letters and papers to be published in academic journals.¹ Specifically, the EAA FRSC set up an agenda working group on the Conceptual Framework chaired by Ken Peasnell (Lancaster University), a group that is open to all members of the EAA who are willing to contribute. The Siena Open Forum: Conceptual Framework was a part of the EAA FRSC's feedback initiatives.

Following this introduction, Graeme Dean canvassed some of the main issues. Controversies surrounding the CF debates, historically and currently, were outlined, based on Dean and Clarke (2003). Wells (2003) summarizes Dean and Clarke:

The views of the Sydney School on what a conceptual framework entails underpinned much of his overview.² In essence, it was suggested this matter requires a focus on commercial fundamentals—to ground any accounting theory foundations in those fundamentals. This begs the question: What is the function of accounting? There needs to be recognition of the multi-objective nature of any theory of accounting—that is, that accounting is a service activity, and that it is a communication device that entails recourse to measurement. A recent historical paper covering evidence from the fifteenth century on the purposes of double-entry booking (Edwards et al., 2008) reveals a lineage of authors proposing accounting as an informational device rather than simply an accountability mechanism. Several purposes of accounting were identified in those early treatises—‘accounts as a means of establishing financial position’, ‘accounts as a means of measuring profitability and changes in financial position’, ‘the construction, content and role of merchandise accounts’ and ‘the use of accounts for purposes of performance assessment and decision making’. They remain appropriate today.

Accordingly, Dean proposed that any CF deliberations need to recognize that those multiple functions have to be addressed simultaneously. Clearly this issue generates tension, as discussed below, and many of the attendees argued that a stewardship or decision usefulness focus should have primacy.

Seeking to stimulate discussion Dean observed that there existed criticism of the ‘constitution’ approach of existing, professionally endorsed accounting CFs (see Chambers, 1996). He referred to what has occurred since the first professional discussions on the CF in the 1970s, noting that that if standards setters do not consider in more depth matters of history, then we are likely to see a repeat of the recurring criticisms of accounting which have been a feature in the last four decades. And which are occurring presently in repercussions of the subprime mortgage lending crisis.

Dean identified some earlier instances of the ‘losses of market confidence’ in the ability of regulators generally, and specifically in audited accounting data failing repeatedly over many decades to provide the required financial sunlight to the market. As a quality control device accounting repeatedly has not measured up to expectations. He suggested that it was crucial for standards setters to identify what were (and are today) the catalysts for a CF in accounting. Any framework that is developed needs to consider the function of accounting in both good (boom) and bad (bust) economic times. The driving factor to be considered is a concern expressed by the users (including regulators) that accounting for similar transactions by different companies should be the same. This has been expressed by standards setters over many decades as a desire to ‘narrow the areas of difference’. Dean agreed with this view, arguing that special pleading for particular exemptions should be ignored.

Crises spurned by varying catalysts have recurred over the last seventy-five years in Anglo-Saxon countries, including the 1930s ‘financial crises’ where similar calls appeared for better ‘principles’, ‘rules’‘standards’ and (say) ‘an integrated set of concepts’; again in the aftermath of the 1960s scandals; and finally, in responses to address the ‘earnings management’ and other financial dilemmas emerging post-Enron.

In sum, it was suggested that history reveals that in boom times pressures are placed on regulators when companies are seen to have engaged in various creative accounting practices for similar transactions—described variously as ‘manipulating accounts’, ‘cooking the books’ or ‘earnings management’. The settings vary and include: accounting for mergers and accounting for changing prices and price levels. Conversely, in economic downturns pressures occur with unexpected collapses of large companies that had previously reported no sign of the deleterious drift in their financial affairs as reported in their audited financial statements.

Above, mention was made of the apparently conflicting views of stewardship and decision usefulness. What continues to be lacking in the professional deliberations is the recognition that such conflicting views need some objective (or function of accounting) in order to act as a limiting constraint.

Further, in the discussions from the previous day's related Fair Value papers, it was contestable whether one could achieve a unique general solution to finding an acceptable measurement basis for all financial statement items. Such contestability has a long history—especially whether one could arrive at a prescribed information set generally relevant for decisions or information specifically relevant for different decisions—and those issues are well captured in (amongst others) the 1970s debates between Gerboth (1972), Demski (1973) and Chambers (1973, 1976). Whittington (2008) notes a view similar to Demski:

The matter of ongoing problems with terminology was another one thought to underpin continuing problems in accounting standards setting and practice. The example was given of the use in the recent FASB Fair Value Measurement deliberations—where reference was made to unit of account (in the sense of a level of activity) rather than its long-held use as medium of exchange. Given that a phrase has a well-accepted meaning in a discipline or technical field, it was suggested by Dean and later by some attendees that transporting that phrase into another context in the same discipline is likely to be counterproductive.

The question of terminological dilemmas is aptly discussed in this journal in Sterling (2003). Sterling laments (as does Whittington, 2008, more generally) the frustrations of an academic standard setter—with the institution being the FASB—when in the early 1980s, in the aftermath of the Savings and Loans crisis, the regulator sought to respond in a way that would be ‘acceptable’ to the real-estate industry and the Congress. Sterling's experiences led him to observe that ‘muddy language has been the root cause of many of our problems for a very long time. We need to clean up our language’ (p. vi).

Dean concluded by noting that the current CF discussions seem to perpetuate the focus on users when perhaps what is more critical, given that accounting is a technology, is the need to focus on its uses, specifically whether they are serviceable.

Those introductory observations were controversial and laden with views of the Sydney School. But they were meant to stimulate debate, which they did. The Chair then sought discussion from the Forum attendees. Several issues emerged.

Changes in language versus changes in substance. Drawing on the reasoning from the Chair's introduction, some in the audience observed that in the July 2006 FASB/IASB Preliminary Views / IASB Discussion Paper the number of cosmetic language changes was perceived as a matter of concern. For example, when that July 2006 Discussion Paper stated in OB2 that the objective of financial reporting is to provide information that is useful for resource allocation decisions without explicit reference to stewardship, this raised strong criticism among many constituents who view this as an important shift in emphasis of the two objectives.³ This controversy has its roots in the different functions that financial statements have in different socioeconomic environments with resulting differences in accounting traditions. In many countries, in particular outside the Anglo-American sphere, stewardship is of particular importance. In the U.K., stewardship also has a much stronger hold than in the U.S. (see Whittington, 2008, for an extended discussion on this point). Interestingly, in formal institutional standards setting discussions on this topic, it was suggested by several attendees that the academic representatives on standards setting bodies almost always supported the alternative view by two members in AV1.1, namely to retain stewardship as an explicit objective instead of subsuming it as an aspect of the decision-usefulness objective as in OB28.

As Whittington (2008) appositely notes, recourse to other problematic phrases such as ‘beyond reasonable doubt’ and ‘faithful representation’ (see more below) are causing much concern. He also discussed from the floor the problems specifically of recourse in the IASB documents to probability phrases in the context of recognition. He pointed to the different meaning such phrases (also, ‘probable’) have in the documents of the FASB and the IASB.

Closely related is the fundamental issue raised by several attendees concerning who are the target users of financial statements. Starting from a comprehensive list including also employees, customers, government and the general public, both the existing CFs as well as the July 2006 Discussion Paper in OB80 narrow the list down to investors and creditors as ‘primary users’. It is left implied that satisfying these users will satisfy the others in the longer list. And surprisingly, given that accounting is a technology, there is no consideration that perhaps uses rather than users should be the focus.

Discussion from the floor was varied. Joshua Ronen, for example, defended the rationale for this translation, noting it had been well rehearsed in the 1970s deliberations by the Trueblood Committee. However, dropping stewardship as an explicit objective was noted by many in the audience as leading to a perceived downgrade of the importance of existing investors and creditors, reducing them to being potential investors and creditors. Also addressed in this context was the distinction between short horizon and long horizon investors and creditors.

Trade-offs related to qualitative characteristics. Discussion also focused on the removal in the latest IASB DP of the trade-off between ‘relevance’ and ‘reliability’, a feature of extant CFs, to be replaced by a lexicographical ordering where ‘relevance’ is put first when choosing between competing accounting methods. In a situation where accounting method 1 provides slightly more relevant information than method 2, and where the latter clearly dominates method 1 with respect to ‘reliability’, method 1 is to be chosen if it meets the threshold of a minimum level of reliability. Several discussants further voiced their concerns that ‘reliability’ is to be replaced by ‘faithful representation’, a term originating in the FASB SACs. Together with the proposed deletion of ‘prudence’ as a desirable quality characteristic, some in the audience suggested that these changes appear to pave the way for financial statements that provide preparers with more discretion.

Framework completeness was another major area of concern. It was suggested that several settings dictated that different frameworks were required. For example, whether the CF should be sector neutral was raised—Mike Bradbury noted that the dual perspective had been successfully applied in New Zealand for many years. Others adopted the perspective similar to that of Whittington (2008), namely that the issues of both sectors differ so much that they require different frameworks. Another setting that some attendees suggested required multiple frameworks was the differing needs of small-to-medium and large enterprises. It was generally felt that small-to-medium size enterprises did not need to comply with (and hence incur substantial compliance costs) the extensive reporting obligations of larger enterprises. A counter view is that both large and small companies are artifices—creatures of the law—and thus it is reasonable that the financial attributes of those companies need to be similarly reported, that is, that they be subject to the same standards reporting regime.

As well as these general areas, many other specific CF issues were identified from the floor. These included:

Summing Up

It is more than thirty-five years since the major international standards-setting bodies, the IASB and FASB, sought common ways to resolve the need for a set of foundation concepts. Now they have set themselves a five-year time horizon to provide the answer. But, importantly, they have constrained this exercise to tinkering with (patching over) the existing frameworks. As noted by Dean in his Editorial in this issue, critically there does not appear to be any recognition on the part of the current standards setters of the need for simultaneous consideration of the abovementioned multiple functions of accounting.

Given the way the current initiatives appear to be heading, it is the view of Gebhardt and Dean that this latest CF exercise may be destined to become another example of Sterling's ‘recycling of ideas’—without ‘resolving problems’ (1975, 1979). To avoid this, quite a number of the academics attending the Siena Open Forum expressed their willingness to contribute to the fundamental discussions ahead. That Forum and this Commentary (like the earlier 2003 CF Forum reported in Abacus) are first steps in the move to have standards setters understand the significance of the history of the previous CF exercises.