24 June 2013

FEE comments on EFRAG Bulletins: Prudence, Uncertainty, Reliability of Financial Information

EFRAG Getting a Better Framework Prudence Bulletin - comment letter

Prudence should not be considered as a primary factor in the development of accounting standards. Prudence should make its way through other concepts such as reliability and uncertainty in the process of developing and applying accounting standards. However, FEE is quite convinced that, as it is the case in the current applicable standards, prudence should be reflected through the asymmetry of thresholds for recognition of assets and liabilities in the development of accounting standards.

Having reflected appropriately prudence in the recognition of assets and liabilities, the role of prudence in the development (and in the application) of accounting standards may be limited to a general exercise of caution. This means that prudence should not become ‘over-prudence’, for instance by building up unsubstantiated reserves, but that in cases of doubt, caution is exercised in accounting for estimates, etc.

In this respect, FEE believes that the IASB Conceptual Framework would also benefit from explaining the relationship between prudence and neutrality.

EFRAG Getting a Better Framework Uncertainty Bulletin - comment letter

From a purely theoretical perspective, considering uncertainty solely as part of measurement may appear to be a sound option. Indeed, this ensures that the statement of financial position provides a complete picture of the rights and obligations of an entity. However, this completeness may be at the expense of relevance of the information produced.

In particular, if uncertainty is not considered as part of the recognition criteria, entities will end up having to measure contingencies with low level of probabilities. Measuring individual contingencies with low level of probabilities but potentially high outflow of economic resources can yield a wide range of values based on a high level of subjectivity. The relevance and reliability of the resulting information to users is questionable.

In such situations, users appear to be better served through adequate disclosures in the notes to the financial statements rather than unreliably measured assets or liabilities on the statement of financial position.

This is why, on balance, FEE agrees with the Bulletin’s tentative conclusion that uncertainty is not only a matter of measurement and that a probability-based threshold should be retained as part of the recognition criteria of assets and liabilities. Additionally, FEE did not observe the “probability of outflow” criterion to have been a source of abuse or diversity in practice. Accordingly FEE does not believe that the elimination of this criterion would be warranted.

On the other hand, FEE does not believe that it is necessary to include uncertainty in the definition of assets and liabilities. FEE believes that establishing the characteristics of an item (asset, liability, income and expense) is a process distinct from determining whether the item should be recognised in the financial statements. The constraints that lead FEE to accept the incorporation of uncertainty as part of the recognition criteria do not extend to the identification process. In particular, FEE does not share the concern expressed in paragraph 39 of the Bulletin that this would impose a burdensome and redundant analysis on preparers. FEE does not believe that preparers would (should) feel compelled to undertake an extensive search of items that do not meet the recognition criteria unless this is required for another purposes, for example for disclosure purposes.

EFRAG Getting a Better Framework Reliability of Financial Information Bulletin - comment letter

FEE agrees with EFRAG that reliability (including the idea of verifiability) needs to be reinstated as a fundamental characteristic of information in financial statements.

FEE believes that the meaning of “reliability” is better understood than the term “faithful representation” that emanates from the US literature. If indeed, the change by the IASB was motivated by the fact that the concept of reliability was not well understood, it appears that nothing was gained by replacing one term that was misunderstood by one that is not necessarily better understood.

FEE believes that the effect of replacing reliability with faithful representation goes beyond a mere change of word. FEE believes that “reliability” is a broader notion than “faithful representation”. Hence, the quality of the information produced could potentially be affected by the change made to the Conceptual Framework.

More specifically, FEE agrees with paragraph 19 of the Bulletin, that the concept of faithful representation as a replacement to reliability weakens the importance of measurement uncertainty and verifiability.

As an example of the potential consequences, FEE is concerned that use of the concept of faithful representation in the development of the measurement principles could lead to a conclusion that fair value provides a faithful representation of assets and liabilities, whereas cost-based measures do not, without regards to the fact that in some circumstances measurement at fair value is highly uncertain. An example of this is the requirement to measure equity instruments at fair value in IFRS 9 even if it is an investment in equity instruments that do not have a quoted market price in an active market and whose fair value cannot be reliably measured.

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