Proposed changes on Conceptual Framework for Financial Reporting

Business World (10/24/2017; p. S1/4)

SUITS THE C-SUITE By Ma. Genalin Q. Arevalo

As part of its continuing efforts to further streamline and standardize International Financial Reporting Standards (IFRS) around the world, the International Accounting Standards Board (IASB) issued an exposure draft (ED) on the revised Conceptual Framework for Financial Reporting (the Framework).

The Framework is not itself a standard, but is instead akin to the “backbone” upon which the various standards are fleshed out. It provides a clear and consistent set of concepts to help define and standardize the objectives behind the various standards. The Framework not only helps the IASB develop and update IFRS, it also helps the preparers of financial statements create their own policies when no Standard applies to a particular transaction or event, or when a choice of accounting policies is allowed. In addition, it can also help others better understand and interpret IFRS.

One of the reasons behind the proposed changes is to address important areas that the existing Framework does not cover, or where it provides little, unclear or out-of-date guidance.

A high-level summary of certain aspects of the exposure draft follows:

Objective of General Purpose Financial Reporting. Although the term “stewardship” is not utilized in the current Framework, this Framework does describe the essential features of the term. Under the ED, the IASB explicitly included the term “stewardship” to place more emphasis on the importance of providing information that can be used in assessing management’s stewardship of the entity’s resources.

Qualitative Characteristics of Useful Financial Information. The ED brings back the notion of “prudence” or the exercise of caution when making judgments under conditions of uncertainty. Simply put, when exercising prudence, the assets, liabilities, income or expenses of an entity should neither be overstated nor understated. In addition, the ED reintroduces explicit reference to substance over form as part of faithful representation.

Reporting Entity. The existing IFRS provides guidance on how a reporting entity should report financial information but it does not define what a “reporting entity” is. The ED defines a reporting entity as “an entity that chooses, or is required, to present general purpose financial statements.”

The ED also defines combined financial statements as financial statements prepared for two or more entities that do not have a parent-subsidiary relationship with each other. It likewise provides guidance in determining the boundaries of a reporting entity.

Elements of the Financial Statements. The IASB proposes to change the definition of assets and liabilities. For assets, instead of focusing on “a resource controlled by the entity,” the ED changes the definition to “a present economic resource controlled by the entity.” The inclusion of the word “economic” indicates that the focus is more on accounting for both tangible and intangible assets (the “rights” or “bundle of rights”) that have the potential to produce economic benefits. The concept of “control” has been retained in the definition in order to assert that, to be able to recognize an asset, the entity must prove that it does not only have rights to obtain the benefits from the “economic resource” but it also has “the ability to direct the use” of such resource.

For liabilities, the proposed revised definition — “a present obligation of the entity to transfer an economic resource as a result of past events” — highlights the focus on the obligations the entity has as at the reporting date, which arose from past events and the settlement of which the entity has no practical ability to avoid.

Recognition and Derecognition Criteria. The current criteria for recognition require the application of the probability criterion when assessing the inflow or outflow of future economic benefits to or from the entity and the reliable measurement of the cost or value of the item to be recognized. A review of the application of the probability criterion has revealed that there is inconsistency in the application of this criterion. In fact, some standards, such as IFRS 9, the new standard on financial instruments, have no probability criterion. To address this, the IASB proposed a change in the recognition criteria to focus more on the “qualitative characteristics of useful financial information.” This proposed revision states that an element of a financial statement is recognized when such recognition provides users with relevant information, faithful representation and information that results in the benefits exceeding the costs of providing that information.

Derecognition, on the other hand, has no specific guidelines under the current Framework. This resulted in inconsistent approaches in applying the derecognition concept across the standards. The ED has developed derecognition criteria that aims to represent faithfully both the entity’s retained assets and liabilities, and any resulting changes in its assets and liabilities.

Measurement. The IASB proposed a guidance on various measurement bases (historical cost and current value measures). It also acknowledges that in providing relevant information about an asset, liability, income or expense, more than one measurement basis is sometimes necessary.

Presentation and disclosure. The ED covers discussion of the objective and scope of financial statements, and the use of presentation and disclosure as communication tools, and information about financial performance.

The ED discusses high-level concepts that describe what information is included in the financial statements and how that information should be presented and disclosed. In this regard, the IASB introduced the “Disclosure Initiative” project, which is aimed at identifying ways on how to improve disclosures in financial reporting.

We should remember that the Framework is not intended to override any specific standards, but instead, is meant to provide the infrastructure upon which the body of IFRS guidelines can be built. Given this, the proposed changes are not likely to have an immediate impact on most entities, but it may impact those which interpret and formulate accounting policies for situations and transactions where no specific Standard exists.

The IASB targets to issue the revised Conceptual Framework by the first half of 2017.

This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.

Ma. Genalin Q. Arevalo is a Partner of SGV & Co.