Exposure Draft: An improved Conceptual Framework for Financial Reporting: Chapters 1 and 2

May 2008

EXPOSURE DRAFT OF

An improved Conceptual Framework

for Financial Reporting:

Chapter 1: The Objective of Financial Reporting

Chapter 2: Qualitative Characteristics and Constraints

of Decision-useful Financial Reporting Information

Comments to be submitted by 29 September 2008

EDOP Concept FW A4 MAY08 13/5/08 11:11 am Page 1

Exposure Draft

AN IMPROVED CONCEPTUAL

FRAMEWORK FOR

FINANCIAL REPORTING:

Chapter 1 The Objective

of Financial Reporting

Chapter 2 Qualitative Characteristics

and Constraints of Decision-useful

Financial Reporting Information

Comments to be received by 29 September 2008

This exposure draft of two chapters of an improved Conceptual Framework for

Financial Reporting: Chapter 1 The Objective of Financial Reporting and Chapter 2 Qualitative

Characteristics and Constraints of Decision-useful Financial Reporting Information is published

by the International Accounting Standards Board (IASB) for comment only. The

exposure draft has been prepared as part of a joint project by the IASB and the US

Financial Accounting Standards Board and it sets out the boards’ proposals for two

chapters of their proposed common framework. The proposals may be modified in the

light of the comments received before being issued in final form. Comments on the

exposure draft and the Basis for Conclusions on the proposals should be submitted in

writing so as to be received by 29 September 2008. Respondents are asked to send their

comments electronically to the IASB Website (www.iasb.org), using the ‘Open to

Comment’ page.

All responses will be put on the public record unless the respondent requests

confidentiality. However, such requests will not normally be granted unless supported

by good reason, such as commercial confidence.

The IASB, the International Accounting Standards Committee Foundation (IASCF), the

authors and the publishers do not accept responsibility for loss caused to any person

who acts or refrains from acting in reliance on the material in this publication,

whether such loss is caused by negligence or otherwise.

ISBN: 978-1-905590-65-0

ISBN for complete publication (two parts including a discussion paper Preliminary Views

on an improved Conceptual Framework for Financial Reporting: The Reporting Entity):

978-1-905590-67-4

be made for the purpose of preparing comments to be submitted to the IASB, provided

such copies are for personal or intra-organisational use only and are not sold or

disseminated and provided each copy acknowledges the IASCF’s copyright and sets out

the IASB’s address in full. Otherwise, no part of this publication may be translated,

reprinted or reproduced or utilised in any form either in whole or in part or by any

electronic, mechanical or other means, now known or hereafter invented, including

photocopying and recording, or in any information storage and retrieval system,

without prior permission in writing from the IASCF.

The IASB logo/‘Hexagon Device’, ‘eIFRS’, ‘IAS’, ‘IASB’, ‘IASC’, ‘IASCF’, ‘IASs’, ‘IFRIC’,

‘IFRS’, ‘IFRSs’, ‘International Accounting Standards’, ‘International Financial

Reporting Standards’ and ‘SIC’ are Trade Marks of the IASCF.

EXPOSURE DRAFT MAY 2008—CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

3 © Copyright IASCF

CONTENTS

paragraphs

INVITATION TO COMMENT

PREFACE P1–P16

Why the boards are reconsidering their frameworks P4–P7

Developing the common conceptual framework P8–P11

Due process P12

Authoritative status of the framework P13–P16

SUMMARY

CHAPTER 1: THE OBJECTIVE OF FINANCIAL REPORTING

INTRODUCTION OB1

OBJECTIVE OF GENERAL PURPOSE FINANCIAL REPORTING OB2–OB8

General purpose financial reporting OB3–OB4

Capital providers and the entity perspective OB5–OB8

DECISION-USEFULNESS OB9–OB14

Usefulness of financial reporting in assessing cash flow prospects OB10–OB11

Usefulness of financial reporting in assessing stewardship OB12

Limitations of general purpose financial reporting OB13–OB14

INFORMATION ABOUT AN ENTITY’S RESOURCES, CLAIMS ON

THOSE RESOURCES AND CHANGES IN RESOURCES AND CLAIMS OB15–OB24

Economic resources and claims on them OB16–OB17

Changes in economic resources and claims on them OB18–OB24

Changes in resources and claims resulting

from financial performance OB19

Financial performance reflected by accrual accounting OB20–OB22

Financial performance reflected by cash flow accounting OB23

Changes in resources and claims not resulting

from financial performance OB24

MANAGEMENT’S EXPLANATIONS OB25

BASIS FOR CONCLUSIONS ON DRAFT CHAPTER 1 BC1.1–BC1.40

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CHAPTER 2: QUALITATIVE CHARACTERISTICS AND CONSTRAINTS OF

DECISION-USEFUL FINANCIAL REPORTING INFORMATION

INTRODUCTION QC1

FUNDAMENTAL QUALITATIVE CHARACTERISTICS QC2–QC14

Relevance QC3–QC6

Faithful representation QC7–QC11

Application of the fundamental qualitative characteristics QC12–QC14

ENHANCING QUALITATIVE CHARACTERISTICS QC15–QC26

Comparability QC16–QC19

Verifiability QC20–QC21

Timeliness QC22

Understandability QC23–QC24

Application of the enhancing qualitative characteristics QC25–QC26

CONSTRAINTS ON FINANCIAL REPORTING QC27–QC33

Materiality QC28

Cost QC29–QC31

Application of the constraints on financial reporting QC32–QC33

BASIS FOR CONCLUSIONS ON DRAFT CHAPTER 2 BC2.1–BC2.64

APPENDIX

Proposed amendments to the Framework for the Preparation and Presentation

of Financial Statements

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Invitation to comment

The International Accounting Standards Board (IASB) and the US Financial

Accounting Standards Board (FASB) invite comments on all matters in this

exposure draft. Comments are most helpful if they:

(a) indicate the specific paragraph or paragraphs to which the comments

relate

(b) contain a clear rationale

Respondents should submit one comment letter to either the IASB or the FASB.

The boards will share and consider jointly all comment letters received.

Respondents must submit comments in writing by 29 September 2008.

Respondents are also invited to comment on the following questions.

Chapter 1 The objective of financial reporting

Chapter 1 describes the objective of financial reporting, the primary user group

to which financial reporting is directed, the types of decisions made by that group

and the financial information useful to that group in making those decisions.

1 The boards decided that an entity’s financial reporting should be

prepared from the perspective of the entity (entity perspective) rather

than the perspective of its owners or a particular class of owners

(proprietary perspective). (See paragraphs OB5–OB8 and paragraphs

BC1.11–BC1.17.) Do you agree with the boards’ conclusion and the basis

for it? If not, why?

2 The boards decided to identify present and potential capital providers as

the primary user group for general purpose financial reporting.

(See paragraphs OB5–OB8 and paragraphs BC1.18–BC1.24.) Do you agree

with the boards’ conclusion and the basis for it? If not, why?

3 The boards decided that the objective should be broad enough to

encompass all the decisions that equity investors, lenders and other

creditors make in their capacity as capital providers, including resource

allocation decisions as well as decisions made to protect and enhance

EXPOSURE DRAFT MAY 2008—CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

their investments. (See paragraphs OB9–OB12 and paragraphs BC1.24–

BC1.30.) Do you agree with that objective and the boards’ basis for it?

If not, why? Please provide any alternative objective that you think the

boards should consider.

Chapter 2 Qualitative characteristics and constraints of

decision-useful financial reporting information

Chapter 2 describes the qualitative characteristics that make financial

information useful. The qualitative characteristics are complementary concepts

but can be distinguished as fundamental and enhancing based on how they affect

the usefulness of information. Providing financial reporting information is also

subject to two pervasive constraints—materiality and cost. Are the distinctions—

fundamental and enhancing qualitative characteristics and pervasive constraints

of financial reporting—helpful in understanding how the qualitative

characteristics interact and how they are applied in obtaining useful financial

reporting information? If not, why?

1 Do you agree that:

(a) relevance and faithful representation are fundamental qualitative

characteristics? (See paragraphs QC2–QC15 and BC2.3–BC2.24.)

If not, why?

(b) comparability, verifiability, timeliness and understandability are

enhancing qualitative characteristics? (See paragraphs QC17–QC35

and BC2.25–BC2.35.) If not, why?

BC2.60–2.66.) If not, why? Is the importance of the pervasive

constraints relative to the qualitative characteristics appropriately

represented in Chapter 2?

2 The boards have identified two fundamental qualitative characteristics—

relevance and faithful representation:

(a) Financial reporting information that has predictive value or

confirmatory value is relevant.

(b) Financial reporting information that is complete, free from material

error and neutral is said to be a faithful representation of an

economic phenomenon.

(i) Are the fundamental qualitative characteristics appropriately

identified and sufficiently defined for them to be consistently

understood? If not, why?

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(ii) Are the components of the fundamental qualitative

characteristics appropriately identified and sufficiently

defined for them to be consistently understood? If not, why?

3 Are the enhancing qualitative characteristics (comparability, verifiability,

timeliness and understandability) appropriately identified and sufficiently

defined for them to be consistently understood and useful? If not, why?

4 Are the pervasive constraints (materiality and cost) appropriately identified

and sufficiently defined for them to be consistently understood and

useful? If not, why?

EXPOSURE DRAFT MAY 2008—CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

Preface

P1 In July 2006 the US Financial Accounting Standards Board (FASB) and the

International Accounting Standards Board (IASB) jointly published a

discussion paper Preliminary Views on an improved Conceptual Framework for

Financial Reporting: The Objective of Financial Reporting and Qualitative

Characteristics of Decision-useful Financial Reporting Information. That paper

was the first in a series of publications jointly developed by the boards as

part of a project to develop a common conceptual framework for

financial reporting.

P2 The boards received 179 responses related to that discussion paper.

At their meetings in 2007 the boards considered the issues raised by

respondents. This exposure draft is the product of the boards’

redeliberations of the issues being addressed in the first phase of the

project and consideration of responses to the discussion paper.

P3 Both the FASB and the IASB have published this common exposure draft

for public comment. It relates to one part of the boards’ broader

conceptual framework. The boards expect to publish other discussion

papers and exposure drafts to seek comments on other parts of what will

ultimately be an improved conceptual framework for financial reporting.

The boards share the ultimate goal of adopting the improved framework

as a replacement of their existing frameworks.

Why the boards are reconsidering their frameworks

P4 A common goal of the boards—a goal shared by their constituents—is for

their standards to be clearly based on consistent principles. To be

consistent, principles must be rooted in fundamental concepts rather

than a collection of conventions. To consistently achieve useful financial

reporting, the body of standards taken as a whole and the application of

those standards should be based on a framework that is sound,

comprehensive and internally consistent.

P5 The IASB’s Framework for the Preparation and Presentation of Financial

Statements and the FASB’s Concepts Statements articulate concepts that go

a long way towards being an adequate foundation for consistent

standards, and the boards have used them for that purpose. For example,

the bases for conclusions on most of the boards’ standards discuss how

their conclusions are derived from the applicable concepts.

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P6 Another common goal of the boards is the convergence of their standards.

The boards are more closely aligning their agendas to achieve

convergence in future standards, but they will encounter difficulties in

doing that if they base their decisions on different frameworks.

P7 To provide the best foundation for developing principle-based common

standards, the boards have undertaken a joint project to develop a

common and improved conceptual framework. The goals for the project

include updating and refining the existing concepts to reflect changes in

markets, business practices and the economic environment that occurred

in the two or more decades since the concepts were developed.

The boards also intend to improve some parts of the existing frameworks,

such as recognition and measurement, as well as to fill some gaps in the

frameworks. For example, neither framework includes a robust concept

of a reporting entity.

Developing the common conceptual framework

P8 The boards concluded that a comprehensive reconsideration of all

concepts would not be an efficient use of their resources. Many aspects of

their frameworks are consistent with each other and do not seem to need

fundamental revision. Instead, the boards adopted an approach that

focuses mainly on improving their existing frameworks and achieving

their convergence, giving priority to issues that are likely to yield

standard-setting benefits in the near term. When completed, the

common framework will be a single document (like the IASB’s Framework)

rather than a series of Concepts Statements (like the FASB’s conceptual

framework).

P9 The boards decided to focus initially on concepts applicable to business

entities in the private sector. Once concepts for those entities are

developed, the boards will consider the applicability of those concepts to

financial reporting by other entities, such as not-for-profit entities in the

private sector and, in some jurisdictions, business entities in the public

(governmental) sector.

P10 Four phases of the conceptual framework project are currently active.

In this phase, the boards are considering conceptual matters relating to

the objective of financial reporting and the qualitative characteristics of

financial reporting information. Other active phases are considering

many conceptual matters, such as:

(a) definitions of elements of financial statements

(b) the unit of account

EXPOSURE DRAFT MAY 2008—CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

(d) initial and subsequent measurement of elements in financial

statements

(e) the concept of a reporting entity.

P11 The boards will consider in later phases matters of financial statement

presentation and disclosure and, as discussed above, the applicability of

the concepts in earlier phases to other types of entities.

Due process

P12 As part of their due process, the boards plan to consult interested parties

by publishing common discussion papers and exposure drafts on each of

the proposed chapters of the common and improved framework. The

boards may also consult by publishing other due process documents to

seek views on particular issues before developing preliminary views on

those issues. The boards also expect to continue to consult in other ways,

such as through discussions with the IASB’s Standards Advisory Council

and the FASB’s Financial Accounting Standards Advisory Council, and in

round-table and other meetings with interested parties.

Authoritative status of the framework

P13 At present, an entity preparing financial statements under International

Financial Reporting Standards (IFRSs) is required to consider the IASB

Framework when there is no standard or interpretation that specifically

applies to a transaction, other event or condition or that deals with a

similar and related issue.

There is no similar requirement for entities

preparing financial statements in accordance with existing US generally

accepted accounting principles (GAAP). The FASB’s Concepts Statements

have the same authoritative status as accounting textbooks, handbooks

and articles, and a lower authoritative status than practices that are

widely recognised and prevalent either generally or in the industry.

†

*IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors, paragraphs 10 and 11.

† FASB Statement No. 162 The Hierachy of Generally Accepted Accounting Principles, paragraphs 4

and 5. Statement 162 is not yet effective as of publication of this exposure draft but is

expected to be effective before the final version of this Conceptual Framework for

Financial Reporting.

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P14 The boards have not reached a common conclusion on the authoritative

status of the common conceptual framework; however, both have

decided that the common conceptual framework will not have the same

status as financial reporting standards. In particular, the common

framework will not override those standards. Some existing standards

may be inconsistent with the common framework. The boards will

reconsider those standards to the extent that the discrepancies meet the

criteria for adding a project to their agendas.

P15 The boards have also decided that each board, within the context of its

respective current hierarchy, will finalise the common framework as

parts (chapters) are completed. However, later phases of the project may

include consequential amendments to parts of the framework that were

completed in earlier phases. Furthermore, the boards note that their

decision on how to finalise the common conceptual framework may need

to be readdressed when they discuss the placement of the framework

within their respective hierarchies.

P16 The FASB has decided that the authoritative status of the framework

within the US GAAP hierarchy should be considered once the framework

is closer to being substantially complete. However, for the purposes of

providing comments on this exposure draft, and on other discussion

papers and exposure drafts published by the boards during their joint

conceptual framework project, respondents should assume that the

framework’s authoritative status will be elevated in the US GAAP

hierarchy to be comparable to the status of the Framework in IFRSs.

EXPOSURE DRAFT MAY 2008—CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

Summary

Introduction to the Framework

S1 The [draft] Conceptual Framework for Financial Reporting establishes the

concepts that underlie financial reporting. The framework is a coherent

system of concepts that flow from an objective. The objective of financial

reporting is the foundation of the framework. The other concepts provide

guidance on identifying the boundaries of financial reporting; selecting

the transactions, other events and circumstances to be represented; how

they should be recognised and measured (or disclosed); and how they

should be summarised and communicated in financial reports.

Chapter 1 The objective of financial reporting

S2 The objective of general purpose financial reporting is to provide

financial information about the reporting entity that is useful to present

and potential equity investors, lenders and other creditors in making

decisions in their capacity as capital providers. Capital providers are the

primary users of financial reporting. To accomplish the objective,

financial reports should communicate information about an entity’s

economic resources, claims on those resources, and the transactions and

other events and circumstances that change them. The degree to which

that financial information is useful will depend on its qualitative

characteristics.

Chapter 2 Qualitative characteristics and constraints of

decision-useful financial reporting information

S3 Qualitative characteristics are the attributes that make financial

reporting information useful. The qualitative characteristics are

complementary concepts that each contribute to the usefulness of

financial reporting information. However, for analysis purposes it is

helpful to distinguish the qualitative characteristics as either

fundamental or enhancing, depending on how they affect the usefulness

of information. Providing useful financial reporting information is

limited by two pervasive constraints on financial reporting—materiality

and cost.

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S4 Fundamental qualitative characteristics distinguish useful financial

reporting information from information that is not useful or is

misleading. For financial information to be useful, it must possess the

two fundamental qualitative characteristics—relevance and faithful

representation. Relevant information is capable of making a difference

in decision making by virtue of its predictive or confirmatory value.

Financial reporting information is a faithful representation if it depicts

the substance of an economic phenomenon completely, neutrally and

without material error.

S5 Financial reporting information may have varying degrees of usefulness

to different capital providers. Enhancing qualitative characteristics

distinguish more useful information from less useful information. They

enhance the decision-usefulness of financial reporting information that

is relevant and faithfully represented. Enhancing qualitative

characteristics (comparability, verifiability, timeliness and

understandability) should be maximised to the extent possible. However,

the enhancing qualitative characteristics, either individually or in

concert with each other, cannot make information useful for decisions if

that information is irrelevant or not faithfully represented.

S6 Comparable information enables users to identify similarities in and

differences between two sets of economic phenomena. Verifiable

information lends credibility to the assertion that financial reporting

information represents the economic phenomena that it purports to

represent. Timeliness provides information to decision makers when it

has the capacity to influence decisions. Understandability is the quality

of information that enables users to comprehend its meaning.

S7 Providing useful financial reporting information is limited by two

pervasive constraints, materiality and cost. Information is material if its

omission or misstatement could influence the decisions that users make

on the basis of an entity’s financial information. The benefits of

providing financial reporting information should justify the costs of

providing that information.

EXPOSURE DRAFT MAY 2008—CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

[Draft] Conceptual Framework for Financial Reporting

Chapter 1 The objective of financial reporting

Introduction

OB1 The first chapter of the conceptual framework establishes the objective of

general purpose financial reporting by business entities in the private

sector.

The objective of financial reporting is the foundation of the

framework. Other aspects of the framework—qualitative characteristics,

elements of financial statements, definition of a reporting entity,

recognition and measurement, and presentation and disclosure—flow

logically from the objective. Those aspects of the framework help to

ensure that financial reporting achieves its objective.

Objective of general purpose financial reporting

OB2 The objective of general purpose financial reporting is to provide

financial information about the reporting entity that is useful to present

and potential equity investors, lenders and other creditors in making

decisions in their capacity as capital providers. Information that is

decision-useful to capital providers may also be useful to other users of

financial reporting who are not capital providers.

General purpose financial reporting

OB3 The boards’ mandate is to assist in the efficient functioning of economies

and the efficient allocation of resources in capital markets by developing

high quality financial reporting standards. The objective pertains to

financial reporting, which includes but is not limited to financial

statements, and thereby provides a more complete basis on which to

achieve these outcomes.

OB4 General purpose financial reporting is directed to the needs of a wide

range of users rather than only to the needs of a single group. General

purpose financial reporting stems from the information needs of users

who lack the ability to prescribe all the financial information they need

from an entity and must therefore rely, at least partly, on the information

* Throughout the framework, the terms financial reports and financial reporting refer to

general purpose financial reports and reporting, and the term entities (or entity) refers to

business entities (or entity).

CHAPTER 1 THE OBJECTIVE OF FINANCIAL REPORTING

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provided in financial reports. Information needed to satisfy the

specialised needs of some users may be beyond the scope of general

purpose financial reporting. The boards intend to consider the

boundaries of general purpose financial reporting in a later phase of the

conceptual framework project.

Capital providers and the entity perspective

OB5 The information provided by general purpose financial reporting focuses

on the needs of all capital providers (those with a claim on the entity’s

resources), not just the needs of a particular group. Financial reports

reflect the perspective of the entity rather than the perspective of the

entity’s equity investors, a particular group of its equity investors or any

other group of capital providers. Adopting the entity perspective does not

preclude the inclusion in financial reports of additional information that

is primarily directed to the needs of an entity’s equity investors or to

another group of capital providers. For example, financial reports often

include quantitative measures such as earnings per share, which may be

of particular interest to holders and potential purchasers of those shares.

OB6 An entity obtains economic resources from capital providers in exchange

for claims on those resources. By virtue of those claims, capital providers

have the most critical and immediate need for general purpose financial

information about the economic resources of an entity. Accordingly,

financial reporting should provide information about the economic

resources of an entity (its assets) and the claims on those resources (its

liabilities and equity). Capital providers include equity investors, lenders

and other creditors, who have common information needs.

(a) Equity investors. Equity investors include holders of equity securities,

holders of partnership interests, and other equity owners. Equity

investors generally invest economic resources (usually cash) in an

entity with the expectation of receiving a return

on, as well as a

return

of, the cash provided; in other words, they expect to receive

more cash than they provided in the form of cash distributions and

increases in the prices of shares or other ownership interests.

Therefore, equity investors are directly interested in the amount,

timing and uncertainty of an entity’s future cash flows and also in

how the perception of an entity’s ability to generate those cash

flows affects the prices of their equity interests. Equity investors

often have the right to vote on management actions and therefore

are interested in how well the directors and management of the

entity have discharged their responsibility to make efficient and

profitable use of the assets entrusted to them.

EXPOSURE DRAFT MAY 2008—CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

(b) Lenders. Lenders, including purchasers of traded debt instruments,

provide financial capital to an entity by lending it economic

resources (usually cash). Lenders generally expect to receive a

return in the form of interest, repayments of borrowings and

increases in the prices of debt securities. Like equity investors,

lenders are interested in the amount, timing and uncertainty of an

entity’s future cash flows and in how the perception of an entity’s

ability to generate those cash flows affects the prices of its debt

securities. Lenders may also have the right to influence or approve

some management actions and therefore may also be interested in

how well management has discharged its responsibilities.

their relationship with an entity, even though the relationship is

not primarily that of a capital provider. For example, employees

provide human capital in exchange for a salary or other

remuneration, some of which may be deferred for many years.

Suppliers may extend credit to facilitate a sale. A customer may

prepay for goods or services to be provided by the entity. To the

extent that employees, suppliers, customers or other groups make

decisions relating to providing capital to the entity in the form of

credit, they are capital providers.

OB7 The primary user group includes both present and potential equity

investors, lenders and other creditors, regardless of how they obtained, or

will obtain, their interests. In the framework, the terms capital providers

and claimants are used interchangeably to refer to the primary user group.

OB8 Managers and the governing board of an entity (herein collectively

referred to as management) are also interested in financial information

about the entity. However, management’s primary relationship with the

entity is not that of a capital provider. Management is responsible for

preparing financial reports; management is not their intended recipient.

Other users who have specialised needs, such as suppliers, customers and

employees (when not acting as capital providers), as well as governments

and their agencies and members of the public, may also find useful the

information that meets the needs of capital providers; however, financial

reporting is not primarily directed to these other groups because capital

providers have more direct and immediate needs.

CHAPTER 1 THE OBJECTIVE OF FINANCIAL REPORTING

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Decision-usefulness

OB9 Capital providers are interested in financial reporting because it provides

information that is useful for making decisions. The decisions that

capital providers make include whether and how to allocate their

resources to a particular entity (ie whether and how to provide capital)

and whether and how to protect or enhance their investments. When

making those decisions, capital providers are interested in assessing the

entity’s ability to generate net cash inflows and management’s ability to

protect and enhance the capital providers’ investments.

Usefulness of financial reporting in assessing cash

flow prospects

OB10 An entity’s capital providers are directly interested in the amount, timing

and uncertainty of cash flows from dividends, interest, and the sale,

redemption or maturity of securities or loans. However, the prospects for

those cash flows depend on the entity’s existing cash resources and, of

more importance, on its ability to generate enough cash to pay its

employees and suppliers and satisfy its other operating needs, to meet its

obligations when due, and to reinvest in operations. The judgements of

capital market participants about the entity’s ability to generate net cash

inflows affect the values of debt or equity interests. Therefore, those

judgements may also affect cash flows to the entity’s capital providers

through sale of their interests.

OB11 Other users of financial reports also have either a direct interest or an

indirect interest in an entity’s ability to generate net cash inflows.

For example, although an entity is not a direct source of cash flows to its

customers, an entity can provide goods or services to customers only by

generating sufficient cash to pay for the resources it uses and to satisfy its

other obligations. Thus, information that meets the needs of capital

providers is also likely to be useful to members of other groups who are

interested in financial information about an entity.

Usefulness of financial reporting in assessing

stewardship

OB12 Management is accountable to the entity’s capital providers for the

custody and safekeeping of the entity’s economic resources and for their

efficient and profitable use. Management’s responsibilities include, to

the extent possible, protecting the entity’s economic resources from

unfavourable effects of economic factors such as price changes and

EXPOSURE DRAFT MAY 2008—CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

technological and social changes. Management is also accountable for

ensuring that the entity complies with applicable laws, regulations and

contractual provisions. Management’s performance in discharging its

responsibilities, often referred to as stewardship responsibilities, is

particularly important to existing equity investors when making

decisions in their capacity as owners about whether to replace or

reappoint management, how to remunerate management, and how to

vote on shareholder proposals about management’s policies and other

matters. Because management’s performance in discharging its

stewardship responsibilities usually affects an entity’s ability to generate

net cash inflows, management’s performance is also of interest to

potential capital providers who are interested in providing capital to the

entity.

Limitations of general purpose financial reporting

OB13 Financial reporting by a particular entity is but one source of information

needed by capital providers. Those users of financial reports also need to

consider pertinent information from other sources, for example,

information about general economic conditions or expectations, political

events and political climate, and industry and company outlooks. Users

also need to be aware of the characteristics and limitations of the

information provided by financial reports.

OB14 To a significant extent, financial reporting information is based on

estimates, judgements and models of the financial effects on an entity of

transactions and other events and circumstances that have happened or

that exist, rather than on exact depictions of those effects. The framework

establishes the concepts that underlie those estimates, judgements and

models and other aspects of financial reports. The concepts are the goal or

ideal towards which standard-setters and preparers of financial reports

should strive. As with most goals, the framework’s vision of ideal financial

reporting is unlikely to be achieved in full, at least not in the short term,

because of technical infeasibility and cost. In some areas, standard-setters

and users of financial reports may need to accept estimates, judgements

and models based more on accounting conventions than on the concepts

in the framework. Nevertheless, establishing a goal towards which to strive

is essential if financial reporting is to evolve so as to improve the

information provided to capital providers and others for use in making

decisions.

CHAPTER 1 THE OBJECTIVE OF FINANCIAL REPORTING

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Information about an entity’s resources, claims on those

resources and changes in resources and claims

OB15 Financial reporting should provide information about the economic

resources of the entity (its assets) and the claims on those resources

(its liabilities and equity). Financial reporting should also provide

information about the effects of transactions and other events and

circumstances that change an entity’s economic resources and the claims

on those resources. That information is useful to capital providers for

assessing an entity’s ability to generate net cash inflows and for assessing

the effectiveness with which management has fulfilled its stewardship

responsibilities.

Economic resources and claims on them

OB16 Information about an entity’s economic resources and the claims on

them—its financial position—can provide a user of the entity’s financial

reports with a good deal of insight into the amount, timing and

uncertainty of its future cash flows. That information helps capital

providers to identify the entity’s financial strengths and weaknesses and

to assess its liquidity and solvency. Moreover, it indicates the cash flow

potentials of some economic resources and the cash needed to satisfy

most claims of lenders and other creditors. Users also assess the

effectiveness with which management has discharged its stewardship

responsibilities to capital providers by comparing their expectations with

actual results. Some of an entity’s economic resources, such as accounts

receivable, are direct sources of future cash inflows. In addition, many

lenders’ and other creditors’ claims, such as debt instruments, are direct

causes of future cash outflows. However, many of the cash flows

generated by an entity’s operations result from combining several of its

economic resources to produce, provide and market goods or services to

customers. Although those cash flows cannot be identified with

individual economic resources (or claims), capital providers need to know

the nature and quantity of the resources available for use in an entity’s

operations. That information is also likely to help those who wish to

estimate the value of the entity; however, financial reports are not

designed to show the value of an entity.

EXPOSURE DRAFT MAY 2008—CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

OB17 Information about an entity’s financial structure, as reflected in its

financial position, helps users to assess its needs for additional borrowing

or other financing and how successful it is likely to be in obtaining that

financing. This information also helps users to predict how future cash

flows will be distributed among those with a claim on the entity’s

economic resources.

Changes in economic resources and claims on them

OB18 Information about effects of transactions and other events and

circumstances that change an entity’s economic resources and the claims

on them helps a user of the entity’s financial reports to assess the amount,

timing and uncertainty of its future cash flows. Such information also

helps a user to assess the effectiveness with which management has

discharged its stewardship responsibilities to the capital providers of the

entity. That information includes quantitative measures and other

information about changes in economic resources and claims that are a

result of the entity’s financial performance, which are reflected by accrual

accounting and cash flows during a period, and changes that are not a

result of the entity’s financial performance (such as financing transactions

between the entity and its owners).

Changes in resources and claims resulting from financial

performance

OB19 An entity’s financial performance provides information about the return

it has produced on its economic resources. In the long run, an entity

must produce a positive return on its economic resources if it is to

generate net cash inflows and thus provide a return to its capital

providers. The variability of that return is also important, especially in

assessing the uncertainty of future cash flows, as is information about the

components of that return. Capital providers usually find information

about an entity’s past financial performance helpful in predicting the

entity’s future returns on its resources and also in assessing

management’s ability to discharge its stewardship responsibilities to its

capital providers.

Financial performance reflected by accrual accounting

OB20 Accrual accounting depicts the financial effects of transactions and other

events and circumstances that have cash or other consequences for an

entity’s resources and the claims on them in the periods in which those

transactions, events or circumstances occur. The buying, producing,

selling and other operations of an entity during a period, as well as

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changes in fair value and other events that affect its economic resources

and the claims on them, often do not coincide with the cash receipts and

payments of the period. Information in financial reports about an

entity’s resources and claims and changes in resources and claims

generally provides a better basis for assessing past performance and

future prospects than information solely about the entity’s current cash

receipts and payments. Without accrual accounting, important

economic resources and claims on resources would be excluded from

financial statements.

OB21 Information about an entity’s financial performance during a period

reflected by changes in its resources and the claims on those resources,

other than changes resulting from financing transactions, is also useful

in assessing the entity’s past and future ability to generate net cash

inflows. That information indicates the extent to which the entity has

increased its available economic resources, and thus its capacity for

generating net cash inflows, through its operations rather than by

obtaining additional capital from capital providers.

OB22 Information about an entity’s financial performance during a period

depicted by changes in its resources and the claims on those resources

may also indicate the extent to which events, such as changes in market

prices or interest rates, have increased or decreased the entity’s economic

resources and the claims on those resources, thereby affecting the entity’s

ability to generate net cash inflows.

Financial performance reflected by cash flow accounting

OB23 Information about an entity’s cash flows during a period also helps users

to assess the entity’s ability to generate future net cash inflows.

Information about an entity’s cash flows during a period indicates how it

obtains and spends cash, including information about its borrowing and

repayment of borrowing, cash dividends or other distributions to equity

owners, and other factors that may affect the entity’s liquidity or

solvency. Capital providers use information about cash flows to help

them understand an entity’s business model and operations, evaluate its

financing and investing activities, assess its liquidity or solvency, or

interpret information provided about financial performance.

Changes in resources and claims not resulting from financial

performance

OB24 Financial reporting should also provide information about changes in an

entity’s economic resources and claims on those resources that do not

result from its financial performance, such as financing transactions

EXPOSURE DRAFT MAY 2008—CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

between the entity and its owners. This information helps capital

providers to distinguish between changes that are the result of the

entity’s financial performance and those that are not. By distinguishing

between these changes, capital providers can assess to what extent the

total change in economic resources and claims on those resources are

attributable to management’s ability to protect and enhance the entity’s

economic resources and, therefore, form expectations about its future

financial performance.

Management’s explanations

OB25 Financial reporting should include management’s explanations and

other information needed to enable users to understand the information

provided. Management’s explanations of the information in financial

reports enhance the ability of capital providers to assess the entity’s

performance and form expectations about the entity. Management

knows more about the entity than external users and can often increase

the usefulness of financial reports by identifying and explaining

particular transactions and other events and circumstances that have

affected or may affect the entity. In addition, financial reporting often

provides information that depends on, or is affected by, management’s

estimates and judgements. Capital providers are better able to evaluate

financial information when they are provided with management’s

explanations of underlying assumptions or methods used, including

disclosure of significant uncertainties about principal underlying

assumptions or estimates.

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Basis for Conclusions on draft Chapter 1

Introduction

BC1.1 This Basis for Conclusions summarises considerations that Board members

thought significant in reaching the conclusions in Chapter 1 The objective of

financial reporting of the draft conceptual framework. It includes reasons for

accepting some alternatives and rejecting others. Individual Board

members gave greater weight to some factors than to others.

BC1.2 In July 2006 the boards published for public comment a discussion paper

Preliminary Views on an improved Conceptual Framework for Financial Reporting:

The Objective of Financial Reporting and Qualitative Characteristics of Decision-

useful Financial Reporting Information. The boards received 179 comment

letters on that discussion paper. This exposure draft represents the

boards’ views after considering respondents’ comments and the views

received through other outreach initiatives. When appropriate, this

appendix discusses the boards’ basis for modifying their preliminary

views to reach the conclusions in this exposure draft.

General purpose financial reporting

BC1.3 FASB Concepts Statement No. 1 Objectives of Financial Reporting by Business

Enterprises focuses on financial reporting, and the IASB Framework focuses

only on financial statements. That difference is not as significant as it

might first appear because the primary focus of the FASB’s conceptual

framework is on financial statements. Initial plans for the FASB’s

conceptual framework contemplated the development of concepts to

establish the boundaries of financial reporting and to distinguish

between information that should be provided in financial statements and

information to be provided in financial reporting outside financial

statements. Work on those concepts was begun but never completed.

BC1.4 The boards concluded that the objective should be broad enough to

encompass information that might eventually be provided by financial

reporting outside financial statements. Thus, the objective pertains to

financial reporting as a whole, not just to financial statements. However,

financial statements are a central part of financial reporting, and most of

the issues that need to be resolved to enable the boards to make progress

on standards projects involve financial statements. Therefore, the boards

EXPOSURE DRAFT MAY 2008—CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

also concluded that consideration of specific issues concerning the

boundaries of financial reporting and distinctions between financial

statements and other parts of financial reporting should be deferred to a

later phase of the conceptual framework project.

BC1.5 The boards do not expect that resolution of issues in that later phase will

significantly change the objective of financial reporting stated in the

framework. However, reaching conclusions on the boundaries of

financial reporting might result in adding information helpful in

achieving the objective. For example, whether financial reporting should

include prospective information or forecasts and, if so, how that

information should be provided, will be considered as part of that phase.

Common needs of users

BC1.6 General purpose financial reporting stems from the common

information needs of users, particularly capital providers. Other users of

financial statements have specialised information needs that go beyond

those of an entity’s capital providers. Those other users may have the

authority to demand information from all of the entities for which

information is desired. Therefore, the boards concluded that, to the

extent that the needs of those other users do not overlap with the

common needs of capital providers, those needs are beyond the scope of

general purpose financial reporting.

One set of general purpose financial reports

BC1.7 Some have suggested that the focus on a single set of financial reports

intended to meet the needs of a wide range of users may no longer be

appropriate. They think that advances in technology may make general

purpose financial reporting obsolete. New technologies, for example the

use of eXtensible Business Reporting Language (XBRL), may make it

practicable for entities either to prepare or to make available the

information necessary for different users to assemble different financial

reports.

BC1.8 To provide different reports for different users or to make available the

information that users need to assemble their own reports raises

cost-benefit concerns. This would place potentially unreasonable demands

on many users of financial reporting information. For example, to make

informed choices about which of several financial reports to select or

which information to select to assemble their own reports or perhaps a

single financial statement, many users would need to have a greater

understanding of accounting than they have now. Many users of financial

CHAPTER 1 THE OBJECTIVE OF FINANCIAL REPORTING

25 © Copyright IASCF

reports are not accounting experts and may not wish to acquire such

expertise. Furthermore, requiring entities to provide either a variety of

different reporting packages or the information sufficient for users to

assemble their own reporting packages would also greatly expand the

amount of information that entities must make available. That would

increase both the costs of providing financial reports and the costs of using

them in exchange for benefits that seem questionable, especially if users

continue to want general purpose financial reports.

BC1.9 The boards concluded that, at least for the time being, users’ information

needs continue to be best served by general purpose financial reports.

Moreover, because users of financial reports have a common interest in

assessing an entity’s ability to generate net cash inflows and

management’s ability to protect and enhance the investments of capital

providers, a financial report that focuses on information that is helpful

in making those assessments is likely to continue to be needed regardless

of how much additional financial data are made available to users.

BC1.10 In the discussion paper, the boards used the term general purpose external

financial reporting. External was intended to convey that internal users

such as management were not intended beneficiaries for financial

reporting established by the boards. During their redeliberations, the

boards concluded that this distinction was unnecessary because

management reporting is not general purpose financial reporting.

In addition, the boards observed that external might imply that a

controlling shareholder was not included in the primary user group

because the controlling shareholder might be deemed to be an internal

user. The boards think the objective of general purpose financial

reporting should encompass the needs of all capital providers.

Therefore, the exposure draft uses general purpose financial reporting.

Entity perspective

BC1.11 Both the FASB’s and the IASB’s existing frameworks discuss the objective

of financial reporting in terms of information that is useful to a wide

range of users in making economic decisions. Both frameworks list a

variety of existing and potential users, including equity investors,

lenders, other creditors, employees, suppliers, customers and

governmental agencies.

BC1.12 Under the entity perspective (also known as the entity theory) the

reporting entity is deemed to have substance of its own, separate from

that of its owners. Economic resources provided by capital providers

EXPOSURE DRAFT MAY 2008—CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

become resources of the entity and cease to be resources of the capital

providers. In exchange for the resources provided, capital providers are

granted claims on the economic resources of the reporting entity. Claims

of different capital providers have different priorities and different rights

with respect to the reporting entity, but they all represent claims on the

economic resources of the reporting entity. Therefore, financial

reporting from the perspective of the entity involves reporting on the

economic resources of that entity and the claims on those resources held

by its capital providers.

BC1.13 In contrast, under the proprietary perspective (also known as the

proprietary theory), the reporting entity does not have substance of its

own separately from that of its proprietors or owners. The resources of

equity capital providers remain their resources and do not become

resources of an entity because the entity does not exist separately from its

owners. Lenders and other creditors provide economic resources to the

owners of an entity in exchange for a claim against the resources that

would otherwise accrue to the benefit of the owners. In other words, the

claims of lenders and other creditors reduce the owners’ equity in the

resources associated with the reporting entity. Therefore, financial

reporting from the perspective of the proprietor involves reporting on the

assets of the owners, the liabilities of the owners to their lenders and other

creditors, and the net residual owners’ equity in the reporting entity.

BC1.14 The proprietary perspective has its roots in the days when most

businesses were sole proprietorships and partnerships that were

managed by their owners. When most entities were owner-managed and

owner-managers had unlimited liability for the debts incurred in the

course of the business, the business did not have any substance separate

from that of the owner. Over time, the separation grew between the

owners of businesses and the businesses themselves. New ways of

conducting business evolved in which the owners did not actively

manage the business, but instead engaged others to do so. As businesses

grew larger and capital needs increased, new business forms evolved as

well. Most of today’s businesses that are the focus of the objective of

financial reporting have legal substance by virtue of their legal form of

organisation, multiple capital providers with limited legal liability, and

professional managers separate from the capital providers.

BC1.15 The boards concluded that the entity perspective is more consistent with

the fact that the vast majority of today’s business entities engaged in

financial reporting have substance distinct from that of their capital

providers. As such, the proprietary perspective generally does not reflect

a realistic view of financial reporting.

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BC1.16 Questions continue to be raised about the standards-level implications of

adopting the entity perspective of financial reporting. Some constituents

argue that an entity perspective logically rules out some alternatives for

the elements of financial statements, for determining the boundaries of

a reporting entity, or for other future phases of the conceptual

framework project. Others argue that although the entity perspective is

helpful for defining the primary user group and the objective of financial

reporting, it does not have important implications for later phases of the

conceptual framework project. Although the boards decided to adopt the

entity perspective as it pertains to the objective of financial reporting,

they have not yet considered all the possible implications of that decision

on future phases of the framework. The boards have not yet considered

the effect that adopting the entity perspective in Chapter 1 will have on

phases that have yet to be deliberated, and therefore have not yet decided

whether there are implications for decisions to be made in those phases.

Those decisions will be made when the boards deliberate those phases.

Primary user group

BC1.17 Both the FASB’s and the IASB’s existing frameworks identify a particular

group of primary users. Information that satisfies the needs of that

particular group of users is likely to meet most of the needs of other users.

The IASB Framework, paragraph 10, says:

As investors are providers of risk capital to the entity, the provision of

financial statements that meet their needs will also meet most of the needs

of other users that financial statements can satisfy.

FASB Concepts Statement 1 focuses on information for investment and

credit decisions, which means that existing and potential investors,

lenders, and other creditors are the primary users on which the objective

focuses.

BC1.18 The boards concluded that identifying a group of primary users of

financial reports, as the existing frameworks do, provides an important

focus for the objective and the other parts of the conceptual framework.

Without a defined group of primary users, the framework would risk

becoming unduly abstract or vague.

BC1.19 Present and potential capital providers are the most prominent users of

an entity’s financial reports. They have the most critical and immediate

need for the information in financial reports. They are interested in

assessing an entity’s ability to generate future net cash inflows, which

significantly affects the entity’s ability to distribute cash to them in the

EXPOSURE DRAFT MAY 2008—CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

form of dividends or other types of distributions to owners, or interest

and repayment of borrowing. Capital providers also compare the

information in financial reports with their expectations over time to

make decisions about management’s ability to protect and enhance their

investments. Other potential users of financial reports who are not

capital providers also have an interest in making these assessments.

Because present and potential capital providers have the most direct and

immediate interest in an entity’s ability to generate net cash inflows and

management’s ability to protect and enhance capital providers’ interests,

the boards decided to designate them as the primary users of financial

reporting information.

BC1.20 Designating a primary user group that comprises all capital providers,

present and potential, does not imply that financial reporting may

neglect the information needs of existing ordinary shareholders. Rather,

it means that standard-setters should strive to meet the information

needs of all members of the primary user group. The boards expect that

the needs of those other members generally will be essentially the same

as the needs of ordinary shareholders. However, some information may

be more significant to the needs of lenders and other creditors than to

those of existing ordinary shareholders. In that situation, designating

present equity investors as the primary users of financial reporting

information could imply an inadequate focus on the needs of other

capital providers, such as lenders and other creditors.

BC1.21 Although the boards adopted the entity perspective as the basic

perspective underlying financial reports, they also observed that

including in financial reports some information that is primarily

directed to equity investors, present or potential (information that some

view as more consistent with the proprietary perspective), is appropriate.

The boards observed that adopting the entity perspective does not

preclude deciding in future standards also to include in financial

statements information that might be viewed as consistent with a

proprietary perspective.

BC1.22 The boards concluded that a focus on a broader primary user group fulfils

the needs of the full range of capital providers both in jurisdictions with

a corporate governance model defined in the context of shareholders and

in jurisdictions with a corporate governance model that focuses on

stakeholders, which is a broader group than shareholders.

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Usefulness for making decisions

Evaluating past performance and predicting future

cash flows

BC1.23 The existing frameworks of both the IASB and the FASB focus on

providing information that is useful in making economic decisions as the

fundamental objective of financial reporting. As part of that objective,

both frameworks also discuss providing information that is helpful in

assessing how management has fulfilled its stewardship responsibility.

BC1.24 Differing views continue to exist on whether providing information that

is useful in assessing management’s stewardship should be a stated

objective of financial reporting, either in addition to the objective of

providing information that is useful in making resource allocation

decisions or in place of that objective. Views about the meaning and

implications of a stewardship objective differ. Supporters of such an

objective do not necessarily view the implications of a separate objective

focusing on stewardship in the same way. The views of opponents of a

stewardship objective are also diverse.

BC1.25 In the discussion paper, the boards concluded that providing information

that is useful in assessing how management has fulfilled its stewardship

responsibility should remain part of the overall objective of providing

information that is useful in making resource allocation decisions.

The boards concluded that users of financial reports who wish to assess

how well management has discharged its stewardship responsibility

generally are interested in making resource allocation decisions.

The boards also concluded that eliminating any discussion of

stewardship, even with an explanation of why such a discussion is

unnecessary, could erroneously imply that the boards do not think that

financial reports should provide information that is useful in assessing

how management has fulfilled its responsibility to protect and enhance

the investments of capital providers.

BC1.26 The boards also concluded in the discussion paper that adding a separate

objective for stewardship might imply that financial reporting should

attempt to separate the effects of management’s performance from the

effects of events and circumstances that are beyond management’s

control. Examples are general economic conditions and the supply and

demand characteristics of an entity’s inputs and outputs. Moreover, the

EXPOSURE DRAFT MAY 2008—CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

boards observed that those who consider providing information that is

useful in assessing management’s stewardship a broader objective than

decision-usefulness may be confusing corporate governance with

financial reporting.

BC1.27 Several respondents to the discussion paper expressed a concern that the

proposed objective was too narrowly focused on resource allocation

decisions. Although most respondents agreed that decision-usefulness

was the appropriate objective, respondents argued that capital providers

make other decisions that are aided by financial reporting information in

addition to resource allocation decisions. Those decisions, which are

typically made after the decision to allocate resources to a particular

entity, involve influencing management of the entity. For example,

shareholders must decide how to vote on whether to retain directors or

replace them and how members of management should be remunerated

for their services. Shareholders’ decision-making process may include

evaluating how management of the entity performed against

management in competing entities in similiar circumstances.

BC1.28 Capital providers also decide whether to use their influence to affect the

operating and financing decisions made by management. For example,

bondholders often have contractual rights to approve or block particular

actions of management that might have an effect on the bondholders’

investment. A lender with the power to call in a loan may opt to use that

power to persuade management to take a specific course of action in

managing the business. Examples of matters of interest to capital

providers are the performance and strategy of management, corporate

governance and social responsibility.

BC1.29 The boards concluded that the objective of financial reporting should be

broad enough to encompass all the decisions that are made by capital

providers at least in part on the basis of their legitimate reliance on

financial reporting information. Those decisions include resource

allocation decisions as well as subsequent decisions made to protect and

enhance their investment. As a result, the boards modified the proposed

objective in paragraph OB2 to include those decisions made to protect

and enhance an investment.

Decision-usefulness for different types of entities

BC1.30 The boards also considered whether the objective of general purpose

financial reporting should differ for different types of entities.

Possibilities include:

(a) smaller entities versus larger entities

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(b) entities with listed (publicly traded) debt or equity financial

instruments versus those without such instruments (sometimes

referred to as non-public or private entities)

BC1.31 The boards concluded that the objective of general purpose financial

reporting should be the same for all entities that issue such reports. That

conclusion is consistent with the IASB Framework and FASB Concepts

Statement 1, as well as the frameworks of other national standard-setters.

The boards observed that the users of some entities’ financial reports, for

example, smaller, closely held entities, may be able to specify and receive

the information they need. Such entities may have little need to prepare

general purpose financial reports for external users. However, for

entities that have external users of their financial reports, the objective

of the reports issued to them is the same because the information needs

of capital providers generally are the same.

BC1.32 Although the objective of financial reporting is the same for all entities,

cost constraints sometimes may lead standard-setters to permit or

require differences in reporting for some types of entities. In those

situations, standard-setters have concluded that such differences are a

result of variations in the perceived costs and benefits of the information

when applied to different entity types, not different objectives. Financial

reports prepared in accordance with such requirements are nonetheless

intended to meet the objective of financial reporting.

Financial reporting and management’s information

needs

BC1.33 Another issue involves the interaction between general purpose financial

reporting and management’s needs. The proposed framework makes it

clear that general purpose financial reporting is directed to the common

needs of capital providers. An entity’s management has information needs

that differ, to some extent, from those of capital providers. In addition,

management has the ability to access financial information to meet its

unique needs. Thus, general purpose financial reporting is not explicitly

directed to the information needs of management. However, an entity’s

management and its governing board are also interested in the entity’s

ability to generate net cash inflows. Thus, financial reporting information

is likely to be useful to them as well as to capital providers.

EXPOSURE DRAFT MAY 2008—CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

BC1.34 Three additional aspects of the management perspective potentially

pertain to later phases of the conceptual framework project. First,

whether management’s perspective or intentions should affect

recognition or measurement will be considered in the phase of the

project that deals with recognition and measurement concepts. Second,

the extent to which, and how, financial reports should include

management commentary will be addressed in the phase dealing with

presentation and display of financial reporting information. The third

issue is whether some information in financial reports should be

presented in a way that is consistent with how management views the

business. Segment information prepared in accordance with FASB

Statement No. 131 Disclosures about Segments of an Enterprise and Related

Information or IFRS 8 Operating Segments, and financial risk management

information prepared in accordance with IFRS 7 Financial Instruments:

Disclosures, are examples of that type of management perspective. That

issue also will be considered in the phase dealing with presentation and

display of financial reporting information.

The significance of information about financial

performance

BC1.35 Another issue concerning the objective of financial reporting is the

relative importance of information about an entity’s financial

performance provided by comprehensive income and its components.

FASB Concepts Statement 1 (paragraph 43) says:

The primary focus of financial reporting is information about an enterprise’s

performance provided by measures of comprehensive income and its

components. Investors, creditors, and others who are concerned with

assessing the prospects for enterprise net cash inflows are especially

interested in that information.

In contrast, the IASB Framework does not elevate the importance of

information about performance above that of other financial reporting

information.

* Concepts Statement 1 refers to earnings and its components. However, FASB Concepts

Statement No. 6 Elements of Financial Statements substitutes the term comprehensive income for

the term earnings. The latter term is reserved for a component of comprehensive income.

CHAPTER 1 THE OBJECTIVE OF FINANCIAL REPORTING

33 © Copyright IASCF

BC1.36 The boards concluded that it is important for the framework to explain

that to assess an entity’s ability to generate net cash inflows or to assess

management’s discharge of its stewardship responsibility, users need

information about the entity’s financial performance measured by accrual

accounting. However, to designate one type of information as the primary

focus of financial reporting would be inappropriate.

BC1.37 The net change during a period in economic resources and the claims

on them, other than those resulting from transactions with owners as

owners, or components of that net change, may be referred to by a

variety of terms, such as comprehensive income, net income, or profit or loss.

The boards concluded that none of the terms communicates the critical

idea that in measuring performance, an entity first identifies and

measures its economic resources and the claims on them in accordance

with the applicable recognition and measurement guidance. In the

process, the entity separates claims by owners from claims by other

parties. The entity then calculates the net change in economic

resources and claims other than changes resulting from transactions

with owners as owners, as well as the net change in claims by owners.

Displays of those changes in economic resources and displays of the list

of economic resources and claims are equally important.

BC1.38 Information about cash flows during a period is also important in

assessing an entity’s financial performance. However, financial

performance measured by accrual accounting more closely tracks the

occurrence of transactions and other events and circumstances that have

affected the entity’s wealth during the period. In addition, financial

reports based on accrual accounting include much information about an

entity’s existing economic resources and the claims on them that would

be omitted if only cash flows were reported. Thus, the boards concluded

that information about an entity’s economic resources and claims on

them and the changes in resources and claims as reflected by various

measurement attributes within accrual accounting is essential to

assessing the entity’s ability to generate net cash inflows.

Financial position and solvency

BC1.39 In response to suggestions received, the boards considered whether the

main purpose of the statement of financial position should be to provide

information that helps particular groups of users, such as lenders, other

creditors and regulators, to assess the entity’s solvency. The boards noted

that similar questions could be asked about whether other financial

statements should be directed to the needs of particular users.

EXPOSURE DRAFT MAY 2008—CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

BC1.40 The question is not whether information provided in the financial

statements should be helpful in assessing solvency—clearly it should.

Assessing solvency is of interest to capital providers, and the overriding

objective of general purpose financial reporting is to provide information

that is useful to capital providers for making decisions. However, some

have suggested that the statement of financial position should be

directed toward the needs of lenders, other creditors and regulators,

possibly to the exclusion of other users. But to do so would be

inconsistent with the objective of serving the common needs of the

capital providers as the primary user group. Therefore, the boards

rejected the notion of directing the statement of financial position (or

any other particular financial statement) towards the needs of particular

groups of users.

CHAPTER 2 QUALITATIVE CHARACTERISTICS AND CONSTRAINTS OF DECISION-USEFUL

FINANCIAL REPORTING INFORMATION

35 © Copyright IASCF

Chapter 2 Qualitative characteristics and constraints of

decision-useful financial reporting information

Introduction

QC1 The objective of general purpose financial reporting is to provide

financial information about the reporting entity that is useful to

present and potential equity investors, lenders, and other creditors in

making decisions in their capacity as capital providers. Qualitative

characteristics are the attributes that make financial information

useful. They can be distinguished as fundamental or enhancing

characteristics, depending on how they affect the usefulness of the

information. Regardless of its classification, each qualitative

characteristic contributes to the usefulness of financial reporting

information. However, providing useful financial information is limited

by two pervasive constraints on financial reporting—materiality and cost.

Fundamental qualitative characteristics

QC2 Economic phenomena are economic resources, claims on those resources,

and the transactions and other events and circumstances that change

them. Financial reporting information depicts economic phenomena

(that exist or have already occurred) in words and numbers in financial

reports. For financial information to be useful, it must possess two

fundamental qualitative characteristics—relevance and faithful

representation.

Relevance

QC3 Information is relevant if it is capable of making a difference in the

decisions made by users in their capacity as capital providers.

Information about an economic phenomenon is capable of making a

difference when it has predictive value, confirmatory value or both.

Whether information about an economic phenomenon is capable of

making a difference is not dependent on whether the information has

actually made a difference in the past or will definitely make a difference

in the future. Information may be capable of making a difference in a

decision—and thus be relevant—even if some users choose not to take

advantage of it or are already aware of it.

EXPOSURE DRAFT MAY 2008—CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

QC4 Information about an economic phenomenon has predictive value if it has

value as an input to predictive processes used by capital providers to form

their own expectations about the future. Information itself need not be

predictable to have predictive value. Some highly predictable

information may not have any predictive value for a particular purpose.

For example, straight-line depreciation of plant and equipment may be

highly predictable from year to year but may not be very helpful in

assessing an entity’s ability to generate net cash inflows. Also,

information about an economic phenomenon need not be in the form of

an explicit forecast to have predictive value; it needs only to be a useful

input to predictive processes of use to capital providers.

QC5 Information about an economic phenomenon has confirmatory value if

it confirms or changes past (or present) expectations based on previous

evaluations. Information that confirms past expectations increases the

likelihood that the outcomes or results will be as previously expected.

If the information changes expectations, it also changes the perceived

probabilities of the range of possible outcomes.

QC6 The predictive and confirmatory roles of information are interrelated;

information that has predictive value usually also has confirmatory

value. For example, information about the current level and structure of

an entity’s economic resources and claims helps users to predict an

entity’s ability to take advantage of opportunities and to react to adverse

situations. The same information helps to confirm or correct users’ past

predictions about that ability.

Faithful representation

QC7 To be useful in financial reporting, information must be a faithful

representation of the economic phenomena that it purports to represent.

Faithful representation is attained when the depiction of an economic

phenomenon is complete, neutral, and free from material error.

Financial information that faithfully represents an economic

phenomenon depicts the economic substance of the underlying

transaction, event or circumstances, which is not always the same as its

legal form.

QC8 A single economic phenomenon may be represented in multiple ways.

For example, an estimate of the risk transferred in an insurance contract

may be depicted qualitatively (eg a narrative description of the nature of

possible losses) or quantitatively (eg an expected loss). Additionally, a

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single depiction in financial reports may represent multiple economic

phenomena. For example, the presentation of the item called plant and

equipment in a financial statement may represent an aggregate of all of

an entity’s plant and equipment.

QC9 A depiction of an economic phenomenon is complete if it includes all

information that is necessary for faithful representation of the economic

phenomena that it purports to represent. An omission can cause

information to be false or misleading and thus not helpful to the users of

financial reports.

QC10 Neutrality is the absence of bias intended to attain a predetermined

result or to induce a particular behaviour. Neutral information is free

from bias so that it faithfully represents the economic phenomena that

it purports to represent. Neutral information does not colour the image

it communicates to influence behaviour in a particular direction.

Financial reports are not neutral if, by the selection or presentation of

financial information, they influence the making of a decision or

judgement in order to achieve a predetermined result or outcome.

However, to say that financial reporting information should be neutral

does not mean that it should be without purpose or that it should not

influence behaviour. On the contrary, relevant financial reporting

information is, by definition, capable of influencing users’ decisions.

QC11 Faithful representation does not imply total freedom from error in the

depiction of an economic phenomenon because the economic

phenomena presented in financial reports are generally measured under

conditions of uncertainty. Therefore, most financial reporting measures

involve estimates of various types that incorporate management’s

judgement. To represent an economic phenomenon faithfully, an

estimate must be based on the appropriate inputs, and each input must

reflect the best available information. Completeness and neutrality of

estimates (and inputs to estimates) are desirable; however, some

minimum level of accuracy is also necessary for an estimate to be a

faithful representation of an economic phenomenon. For a

representation to imply a degree of completeness, neutrality or freedom

from error that is impracticable would diminish the extent to which the

information faithfully represents the economic phenomena that it

purports to represent. Thus, to attain a faithful representation, it may

sometimes be necessary to disclose explicitly the degree of uncertainty in

the reported financial information.

EXPOSURE DRAFT MAY 2008—CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

Application of the fundamental qualitative

characteristics

QC12 The qualitative characteristic of relevance is concerned with the

connection of economic phenomena to the decisions of capital providers

and other users of financial reporting information—the pertinence of the

phenomena to those decisions. Application of the qualitative

characteristic of relevance will identify which economic phenomena

should be depicted in financial reports, with the intention of providing

decision-useful information about those phenomena. Relevance refers to

the economic phenomena, not to their depictions, and therefore will be

considered before the other qualitative characteristics.

QC13 Once relevance is applied to determine which economic phenomena are

pertinent to the decisions to be made, faithful representation is applied

to determine which depictions of those phenomena best correspond to

the relevant phenomena. Application of the faithful representation

characteristic determines whether a proposed depiction in words and

numbers is faithful (or unfaithful) to the economic phenomena being

depicted.

QC14 As fundamental qualitative characteristics, relevance and faithful

representation work together to contribute to the decision-usefulness of

information in different ways. A depiction that is a faithful

representation of an irrelevant phenomenon is not decision-useful, just

as a depiction that is an unfaithful representation of a relevant

phenomenon results in information that is not decision-useful. Thus,

either irrelevance (the economic phenomenon is not connected to the

decision to be made) or unfaithful representation (the depiction is not

connected to the phenomenon) results in information that is not

decision-useful. Together, relevance and faithful representation make

financial reporting information decision-useful.

Enhancing qualitative characteristics

QC15 Enhancing qualitative characteristics are complementary to the

fundamental qualitative characteristics. Enhancing qualitative

characteristics distinguish more useful information from less useful

information. The enhancing qualitative characteristics are comparability,

verifiability, timeliness and understandability. These characteristics enhance

the decision-usefulness of financial reporting information that is

relevant and faithfully represented.

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Comparability

QC16 Comparability is the quality of information that enables users to identify

similarities in and differences between two sets of economic phenomena.

Consistency refers to the use of the same accounting policies and

procedures, either from period to period within an entity or in a single

period across entities. Comparability is the goal; consistency is a means

to an end that helps in achieving that goal.

QC17 The essence of decision making is choosing between alternatives. Thus,

information about an entity is more useful if it can be compared with

similar information about other entities and with similar information

about the same entity for some other period or some other point in time.

Comparability is not a quality of an individual item of information, but

rather a quality of the relationship between two or more items of

information.

QC18 Comparability should not be confused with uniformity. For information

to be comparable, like things must look alike and different things must

look different. An overemphasis on uniformity may reduce

comparability by making unlike things look alike. Comparability of

financial reporting information is not enhanced by making unlike things

look alike any more than it is by making like things look different.

QC19 Some degree of comparability should be attained by maximising the

fundamental qualitative characteristics. That is to say, a faithful

representation of a relevant economic phenomenon should naturally

possess some degree of comparability to a faithful representation of a

similar relevant economic phenomenon by another entity. Although a

single economic phenomenon can be faithfully represented in multiple

ways, permitting alternative accounting methods for the same economic

phenomenon diminishes comparability and, therefore, may be

undesirable.

Verifiability

QC20 Verifiability is a quality of information that helps assure users that

information faithfully represents the economic phenomena that it

purports to represent. Verifiability implies that different knowledgeable

and independent observers could reach general consensus, although not

necessarily complete agreement, that either:

(a) the information represents the economic phenomena that it

purports to represent without material error or bias; or

EXPOSURE DRAFT MAY 2008—CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

(b) an appropriate recognition or measurement method has been

applied without material error or bias.

To be verifiable, information need not be a single point estimate. A range

of possible amounts and the related probabilities can also be verified.

QC21 Verification may be direct or indirect. With direct verification, an amount

or other representation itself is verified, such as by counting cash or

observing marketable securities and their quoted prices. With indirect

verification, the amount or other representation is verified by checking the

inputs and recalculating the outputs using the same accounting

convention or methodology. An example is verifying the carrying

amount of inventory by checking the inputs (quantities and costs) and

recalculating the ending inventory using the same cost flow assumption

(eg average cost or first-in, first-out).

Timeliness

QC22 Timeliness means having information available to decision makers before

it loses its capacity to influence decisions. Having relevant information

available sooner can enhance its capacity to influence decisions, and a

lack of timeliness can rob information of its potential usefulness. Some

information may continue to be timely long after the end of a reporting

period because some users may continue to consider it when making

decisions. For example, users may need to assess trends in various items

of financial reporting information in making investment or credit

decisions.

Understandability

QC23 Understandability is the quality of information that enables users to

comprehend its meaning. Understandability is enhanced when

information is classified, characterised and presented clearly and

concisely. Comparability can also enhance understandability.

QC24 Although presenting information clearly and concisely helps users to

comprehend it, the actual comprehension or understanding of financial

information depends largely on the users of the financial report. Users of

financial reports are assumed to have a reasonable knowledge of business

and economic activities and to be able to read a financial report.

In making decisions, users also should review and analyse the

information with reasonable diligence. However, when underlying

economic phenomena are particularly complex, fewer users may

understand the financial information depicting those phenomena.

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In those cases, some users may need to seek the aid of an adviser.

Information that is relevant and faithfully represented should not be

excluded from financial reports solely because it may be too complex or

difficult for some users to understand without assistance.

Application of the enhancing qualitative

characteristics

QC25 Enhancing qualitative characteristics improve the usefulness of financial

information and should be maximised to the extent possible. However,

the enhancing qualitative characteristics, either individually or in

concert with each other, cannot make information useful for decisions if

that information is irrelevant or not faithfully represented.

QC26 The application of the enhancing qualitative characteristics is an

iterative process that does not follow a prescribed order. Sometimes, one

or more enhancing qualitative characteristics may be sacrificed to

varying degrees to maximise another qualitative characteristic.

For example, a temporary reduction in comparability may be worthwhile

to improve relevance or faithful representation in the longer term.

A temporary reduction in period-to-period consistency, and thus in

comparability, may occur when a new financial reporting standard that

improves relevance or faithful representation requires prospective

application. Such a change in reporting effectively trades a temporary

reduction in period-to-period consistency for greater comparability in the

future. In that situation, appropriate disclosures can help to compensate

for the temporary reduction in comparability.

Constraints on financial reporting

QC27 Two pervasive constraints limit the information provided by financial

reporting: materiality and cost.

Materiality

QC28 Information is material if its omission or misstatement could influence

the decisions that users make on the basis of an entity’s financial

information. Because materiality depends on the nature and amount of

the item judged in the particular circumstances of its omission or

misstatement, it is not possible to specify a uniform quantitative

threshold at which a particular type of information becomes material.

EXPOSURE DRAFT MAY 2008—CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

When considering whether financial information is a faithful

representation of what it purports to represent, it is important to take into

account materiality because material omissions or misstatements will

result in information that is incomplete, biased or not free from error.

Cost

QC29 Financial reporting imposes costs; the benefits of financial reporting

should justify those costs. Assessing whether the benefits of providing

information justify the related costs will usually be more qualitative than

quantitative. In addition, the qualitative assessment of benefits and

costs will often be incomplete.

QC30 The costs of providing information include costs of collecting and

processing the information, costs of verifying it, and costs of

disseminating it. Users incur the additional costs of analysis and

interpretation. Omission of decision-useful information also imposes

costs, including the costs that users incur to obtain or attempt to estimate

needed information using incomplete data in the financial report or data

available elsewhere. Preparers expend the majority of the effort towards

providing financial information. However, capital providers ultimately

bear the cost of those efforts in the form of reduced returns.

QC31 Financial reporting information helps capital providers make better

decisions, which results in more efficient functioning of capital markets

and a lower cost of capital for the economy as a whole. Individual entities

also enjoy benefits, including improved access to capital markets,

favourable effect on public relations, and perhaps lower costs of capital.

The benefits may also include better management decisions because

financial information used internally is often based at least partly on

information prepared for general purpose financial reporting purposes.

Application of the constraints on financial reporting

QC32 Materiality is a pervasive constraint on financial reporting because it

pertains to all the qualitative characteristics of decision-useful financial

reporting information. For example, materiality should be considered

when determining whether information has sufficient predictive or

confirmatory value to be relevant to users and is sufficiently complete,

neutral and free from error to represent faithfully the economic

phenomenon that it purports to represent.

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QC33 Application of the cost constraint involves assessing whether the benefits

of reporting information are likely to justify the costs incurred to provide

and use that information. When making this assessment, it is necessary

to consider whether one or more qualitative characteristics might be

sacrificed to some degree to reduce cost. When applying the cost

constraint to a proposed standard, standard-setters seek information

from preparers, users, academics and others about the expected nature

and quantity of the benefits and costs of that standard.

EXPOSURE DRAFT MAY 2008—CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

Basis for Conclusions on draft Chapter 2

Introduction

BC2.1 This Basis for Conclusions summarises the considerations that Board

members thought significant in reaching the conclusions in Chapter 2

Qualitative characteristics and constraints of decision-useful financial reporting

information of the draft conceptual framework. It includes reasons for

accepting some alternatives and rejecting others. Individual Board

members gave greater weight to some factors than to others.

BC2.2 In July 2006 the boards published for public comment a discussion paper

Preliminary Views on an improved Conceptual Framework for Financial Reporting:

The Objective of Financial Reporting and Qualitative Characteristics of Decision-

useful Financial Reporting Information. The boards received 179 comment

letters on that discussion paper. This exposure draft represents the

boards’ views after considering respondents’ comments and the views

received through other outreach initiatives. When appropriate, this Basis

for Conclusions discusses the boards’ basis for modifying their

preliminary views to reach the conclusions in this exposure draft.

Fundamental qualitative characteristics

Relevance

Capable of making a difference in decisions

BC2.3 In their existing frameworks, the FASB’s and the IASB’s definitions of

relevance are similar, with one difference. The IASB Framework,

paragraph 26, says that information is relevant ‘when it influences the

economic decisions of users by helping them evaluate past, present or

future events or confirming, or correcting, their past evaluations.’ FASB

Concepts Statement No. 2 Qualitative Characteristics of Accounting

Information, paragraph 47, says that to be relevant, ‘… accounting

information must be capable of making a difference in a decision by

helping users to form predictions about the outcomes of past, present,

and future events or to confirm or correct expectations.’ Thus, the

definitions differ in whether information actually makes a difference or

is capable of making a difference in a decision.

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BC2.4 The boards concluded that information must be capable of making a

difference in a decision to be relevant. In making decisions, users

consider many individual items of financial reporting information, along

with other types of information from many other sources. The extent to

which users’ decisions were affected by a particular item of financial

reporting information often would be difficult to determine, even after

the information has become available.

BC2.5 Whether or not it is possible to demonstrate conclusively that a particular

item of information will affect, or has affected, users’ decisions, the

boards take steps to understand how capital providers use financial

reporting information and how financial reports might better serve their

needs. This includes actively soliciting written comments on proposed

standards from capital providers and other users of financial reporting.

The boards also frequently meet users and user organisations to discuss

not only the potential benefits and costs of proposed standards but also

potential agenda decisions and other matters. Such steps provide

standard-setters with knowledge about the types of information that are

capable of affecting users’ decisions.

BC2.6 In addition, the boards assess relevance in relation to a decision—not in

relation to particular decision makers. For example, some users may have

been obtaining an item of information from a source other than financial

reporting, or some users may have been estimating the amount of an item

that financial reporting does not provide using other items that are

provided. For various reasons, some users may choose not to take

advantage of a particular item of information. However, the fact that some

users have been expending the effort to obtain the information elsewhere

may emphasise the relevance of the information to their decisions.

Predictive and confirmatory value

BC2.7 The IASB Framework identifies predictive value and confirmatory value as

components of relevance, and the FASB’s Concepts Statement 2 refers to

predictive value and feedback value. The boards concluded that confirmatory

value and feedback value have the same meaning. In the interest of

adopting common terminology, the boards decided to use confirmatory

value, which means confirming the validity of prior predictions or

correcting them.

What does predictive value mean?

BC2.8 The boards identified the meaning of predictive value as an issue needing

attention because it is easy to confuse predictive value as used in financial

reporting concepts with predictability and related terms used in statistics.

EXPOSURE DRAFT MAY 2008—CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

BC2.9 Information has predictive value if it can be used in making predictions

about the eventual outcomes of past, present or future events or their

effects on future cash flows. In contrast, statisticians use predictability to

refer to the accuracy with which it is possible to foretell the next number

in a series. This is distinguished from persistence, which refers to the

tendency of a series of numbers to continue as it has been going.

BC2.10 The boards concluded that adopting statistical notions and terminology

in the framework would be inappropriate. To do so would imply that

relevant financial reporting information must, in itself, predict the

future. Although financial reporting might include forward-looking

information, the boards noted that information need not be

forward-looking to have predictive value. Rather, information that has

predictive value is valuable as an input to the processes that capital

providers and others use to develop their own predictions. In other

words, financial reports supply the information; users make the

predictions, including predictions that a reported item will not repeat.

Faithful representation and reliability

BC2.11 Concepts Statement 2, the IASB Framework and other conceptual

frameworks that the boards reviewed include reliability as an essential

qualitative characteristic of decision-useful financial reporting

information. However, the boards identified several issues about

reliability and its components. They also noted that neither board’s

existing framework conveys the meaning of reliability clearly enough to

avoid misunderstandings.

How can the framework best convey what reliability

means?

BC2.12 In Concepts Statement 2, the components of reliability are representational

faithfulness, verifiability and neutrality, and its discussion of representational

faithfulness also encompasses completeness and freedom from bias. The IASB

Framework (paragraph 31) says:

Information has the quality of reliability when it is free from material error

and bias and can be depended upon by users to represent faithfully that

which it either purports to represent or could reasonably be expected to

represent.

Subsequent paragraphs of the IASB Framework (paragraphs 33–38) discuss

substance over form, neutrality, prudence and completeness as aspects of faithful

representation.

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BC2.13 In considering the issues related to reliability, the boards observed that

there is a variety of notions of what the concept means. For example,

some focus on verifiability or free from material error to the virtual exclusion

of the faithful representation aspect of reliability. Others focus more on

faithful representation, perhaps combined with neutrality. And to some,

reliability apparently refers primarily to precision. The comments on

almost any controversial proposal by a standard-setting body also

indicate the lack of a common understanding of reliability. Sometimes,

one group of respondents criticises the proposal as likely to reduce the

reliability of the resulting financial reporting; another group supports

the same proposal as likely to improve reliability. Generally, neither

group explains clearly what it means by reliability, and each group seems

to have in mind a different notion. Those considerations led the boards

to consider how they could better convey what the proposed framework

means by reliability.

BC2.14 Given the nature and extent of the longstanding problems with the

qualitative characteristic of reliability, as well as previous efforts to

address them, the boards concluded that the term itself needed

reconsideration. Because further efforts to explain what reliability means

were not likely to be productive, the boards sought a term that would

more clearly convey the intended meaning.

BC2.15 Faithful representation—the faithful depiction in financial reports of

economic phenomena—is essential if information is to be decision-useful.

To represent economic phenomena faithfully, accounting

representations must be complete, neutral and free from material error.

Accordingly, the boards proposed that faithful representation

encompasses all the key qualities that the previous frameworks included

as aspects of reliability.

BC2.16 Many respondents to the discussion paper commented unfavourably on

the boards’ preliminary decision to replace reliability with faithful

representation. However, in those comments, each respondent described

reliability differently from how the boards described reliability in their

existing frameworks. Furthermore, many respondents’ descriptions of

reliability more closely resembled the boards’ notion of verifiability than

reliability. These comments led the boards to affirm their decision to

replace the term reliability with faithful representation. During their

redeliberations, the boards took several steps to try to prevent further

misunderstandings about faithful representation. These steps included

explicitly identifying freedom from material error as a component of

faithful representation and removing verifiability as a component of it.

EXPOSURE DRAFT MAY 2008—CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

BC2.17 To avoid confusing two similar terms, the remainder of this Basis for

Conclusions uses the term

faithful representation rather than reliability,

except when directly quoting existing frameworks that use the latter term.

Substance over form

BC2.18 The IASB Framework includes substance over form among the components of

reliability. Paragraph 35 includes the following:

For example, an entity may dispose of an asset to another party in such a way

that the documentation purports to pass legal ownership to that party;

nevertheless, agreements may exist that ensure that the entity continues to

enjoy the future economic benefits embodied in the asset. In such

circumstances, the reporting of a sale would not represent faithfully the

transaction entered into...

In contrast, Concepts Statement 2 does not include substance over form

‘because it would be redundant. The quality of … representational

faithfulness leaves no room for accounting representations that

subordinate substance to form’ (paragraph 160).

BC2.19 The boards concluded that faithful representation means that financial

reporting information represents the substance of an economic

phenomenon rather than solely its legal form. To represent legal form

that differs from the economic substance of the underlying economic

phenomenon could not result in a faithful representation. Accordingly,

the proposed framework does not identify substance over form as a

component of faithful representation because to do so would be

redundant.

Neutrality, prudence and conservatism

BC2.20 Both boards’ existing frameworks include neutrality as an essential

component of faithful representation, and both define it similarly.

The FASB’s and the IASB’s existing frameworks also discuss the role of

conservatism or prudence. For example, the following is from paragraphs

92 and 93 of Concepts Statement 2. (The phrase in quotation marks is

from paragraph 171 of APB Statement No. 4 Basic Concepts and Accounting

Principles Underlying Financial Statements of Business Enterprises.)

There is a place for a convention such as conservatism—meaning prudence—in

financial accounting and reporting, because business and economic activities

are surrounded by uncertainty, but it needs to be applied with care. Since a

preference “that possible errors in measurement be in the direction of

understatement rather than overstatement of net income and net assets”

introduces a bias into financial reporting, conservatism tends to conflict with

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significant qualitative characteristics, such as representational faithfulness,

neutrality, and comparability (including consistency) ….

Conservatism in financial reporting should no longer connote deliberate,

consistent understatement of net assets and profits. The Board emphasizes

that point because conservatism has long been identified with the idea that

deliberate understatement is a virtue.

Paragraph 37 of the IASB Framework says that the exercise of prudence is

an appropriate response to the uncertainties inherent in preparing

financial statements. It defines prudence as ‘the inclusion of a degree of

caution in the exercise of the judgements needed in making the

estimates required under conditions of uncertainty, such that assets or

income are not overstated and liabilities or expenses are not

understated.’ However, that paragraph also notes that the exercise of

prudence does not allow for deliberate understatement of assets or

income or overstatement of liabilities or expenses.

BC2.21 Being careful in the presence of uncertainty includes searching for

additional information to reduce uncertainty, reflecting the uncertainty

of a range of potential amounts in making an estimate, or selecting an

amount from the midpoint of a range if a point estimate is required.

Going beyond that to reflect conservative estimates of income and equity

has sometimes been considered desirable to ensure that financial reports

do not reflect excessive optimism or bias on the part of management.

However, the boards concluded that describing prudence or conservatism as

a qualitative characteristic or a desirable response to uncertainty would

conflict with the quality of neutrality because, even with the proscriptions

of deliberate misstatement that appear in the existing frameworks, an

admonition to be prudent is likely to lead to a bias in the reported

financial position and financial performance. Introducing biased

understatement of assets (or overstatement of liabilities) in one period

frequently leads to overstating financial performance in later periods—a

result that cannot be described as prudent. This is inconsistent with

neutrality, which encompasses freedom from bias. Accordingly, the

proposed framework does not include prudence or conservatism as desirable

qualities of financial reporting information.

Can faithful representation be empirically measured?

BC2.22 Another issue involving faithful representation or any other of the

qualitative characteristics is whether the framework should attempt to

develop empirical measures of them. The boards considered whether at

least some aspects of faithful representation might be quantifiable due to

its relation to certain statistical concepts. But how or whether financial

EXPOSURE DRAFT MAY 2008—CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

reporting concepts could objectively quantify neutrality (freedom from

bias) or the overall degree of faithful representation is far from clear.

Conceivably, the boards might attempt to quantify faithful

representation by calculating closeness to an ideal (for example, total

reported assets as a percentage of total ideally recognised and measured

assets). But the so-called ideal would be so subjective, so controversial,

that the attempt at quantification would probably fail.

BC2.23 Empirical accounting research techniques have accumulated considerable

evidence supporting the combination of relevance and faithful

representation of accounting information for measurement purposes by

correlation to market prices and changes in them. For example, some

studies provide evidence that a particular financial reporting requirement

results in information that the market regards as sufficiently relevant and

faithfully represented to be decision-useful. However, such studies have

generally not provided useful techniques for consistently empirically

measuring faithful representation apart from relevance.

BC2.24 Both boards’ existing frameworks note the desirability in some

circumstances of providing statistical information about how faithfully a

financial reporting measure is represented. For example, paragraph 72 of

Concepts Statement 2 says:

… an indication of the probabilities attaching to different values of an

attribute may be the best way of giving information reliably about the

measure of the attribute and the uncertainty that surrounds it.

Paragraph 34 of the IASB Framework includes a similar statement. Other

statistical notions are also sometimes reflected in financial reports.

For example, some entities disclose their value at risk from derivative

financial instruments and similar positions, which is a measure of

expected loss in specified circumstances. The boards expect that the use

of statistical concepts for financial reporting in particular situations will

continue to be important. However, they are unaware of useful means of

quantifying either the overall quality of faithful representation or its

components and concluded that they should not attempt to develop such

means in the proposed framework. In reaching that conclusion, the

boards noted that an inability to quantify characteristics identified as

qualitative is not surprising. A complicating factor is that the meaning

of reliability (faithful representation) in econometrics and statistics is

narrower than the way in which the existing frameworks use the term.

Any attempt to quantify faithful representation or any other of the

qualitative characteristics would presumably require the use of the term

in financial reporting concepts to be reconciled with the use in statistical

analysis.

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Enhancing qualitative characteristics

Comparability

BC2.25 The IASB Framework discusses comparability as a qualitative characteristic

of decision-useful information as equally important as relevance and

faithful representation. Concepts Statement 2 describes comparability as

a quality of the relationship between two or more pieces of information

that, although important, is secondary to relevance and faithful

representation. Both frameworks, however, indicate that comparability

should not be overemphasised at the expense of improved relevance or

faithful representation.

BC2.26 The boards concluded that comparability was an enhancing qualitative

characteristic because it logically follows relevance and faithful

representation. Comparability is achieved when information being

compared is a faithful representation of a relevant phenomenon. When

information faithfully represents relevant phenomena, similar

phenomena are represented similarly and dissimilar phenomena are

represented dissimilarly. Consistency of information across entities or

time periods enhances its comparability, which improves its decision-

usefulness. Regardless of how comparable information may be, it will not

be useful if it is irrelevant to users’ decisions or does not faithfully

represent the economic phenomena it purports to represent. In addition,

standard-setters sometimes temporarily sacrifice some consistency to

achieve improved relevance or faithful representation (or both) of the

information in financial reports. For example, an entity’s adoption of a

new method of accounting or reporting applied prospectively will

temporarily reduce the consistency of its financial reporting, thereby

temporarily decreasing comparability.

Verifiability

BC2.27 The IASB Framework does not include verifiability as an explicit aspect or

component of reliability, yet Concepts Statement 2 does. The boards,

however, noted that their existing frameworks are not as different with

respect to veriability as it might appear because paragraph 31 of the

Framework contains the phrase and can be depended upon by users, which

implies the need for a means of assuring users that they can depend on

the information. In the discussion paper, the boards’ preliminary views

were that information needs to be verifiable to assure users that it is free

from material error and bias and can thus be depended on to represent

what it purports to represent. Therefore, verifiability was a component of

faithful representation.

EXPOSURE DRAFT MAY 2008—CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

BC2.28 Some respondents pointed out that including verifiability as a

component of faithful representation could result in some information

being excluded from financial reporting. For example, an entity can

faithfully depict a piece of information that represents management’s

opinion or intentions and this information is normally useful for

decision-making. However, this information may not necessarily be

directly or indirectly verifiable. The boards observed that many pieces of

information included in financial reports are not verifiable and therefore

concluded that verifiability cannot be a required component of faithful

representation. However, the boards agreed that information that is

verifiable is generally more decision-useful than information that cannot

be independently verified; they therefore concluded that verifiability is

an enhancing qualitative characteristic.

Timeliness

BC2.29 The IASB Framework discusses timeliness separately, as a constraint that

could rob information of relevance. Concepts Statement 2 includes

timeliness as an ancillary aspect of relevance. However, the substance of

the concepts as discussed in the two frameworks is essentially the same.

BC2.30 In the discussion paper, the boards tentatively concluded that timeliness

pertains only to relevance. However, some respondents pointed out that

timeliness affects many of the qualitative characteristics and thus should

not be characterised as a component of relevance. In their

redeliberations, the boards concluded that timeliness is different from

the other components of relevance. Whereas something that has

predictive value or confirmatory value is relevant, information can be

reported in a timely manner and have no relevance at all, or information

can be delayed in reporting and remain relevant. Thus, the boards

concluded that reporting information in a timely manner can enhance

both the relevance and the faithful representation of that information

and, therefore, timeliness is best described as an enhancing qualitative

characteristic.

Understandability

BC2.31 Both the IASB Framework and Concepts Statement 2 include

understandability, a quality of information that enables users to

comprehend its meaning and therefore make it useful for

decision-making. Both frameworks also similarly describe that for

financial reporting information to be understandable, users should have

a reasonable degree of financial knowledge and a willingness to study the

information with reasonable diligence.

CHAPTER 2 QUALITATIVE CHARACTERISTICS AND CONSTRAINTS OF DECISION-USEFUL

FINANCIAL REPORTING INFORMATION

BC2.32 Despite those discussions of understandability and the users’

responsibilities for understanding financial reports, misunderstandings

persist. For example, some have argued that a new accounting method

should not be implemented because some users might not understand it,

even though the new accounting method is useful for decision making.

They imply that understandability is more important than relevance.

BC2.33 The boards concluded that the draft framework needed to clarify both the

qualitative characteristic of understandability and users’ responsibilities

in understanding financial reports. The revised discussion of

understandability now explains that users are responsible for studying

financial reporting information with reasonable diligence rather than

only being willing to do so. In addition, the boards clarified that when an

economic phenomenon is particularly complex, users may need to seek

the aid of an adviser to understand that particular transaction.

For example, capital providers unfamiliar with actions an entity might

take to hedge its exposure to financial risks might have difficulty

understanding a note to the financial statements that explains its

hedging activities. That information, however, is relevant to users in

making decisions about the entity. The understandability of information

about hedging activities and related hedge accounting might be

improved by a standard-setter requiring, or an entity voluntarily

providing, tabular or graphic formats (or both) as well as narrative

explanations. Standard-setters, together with those who prepare

financial reports, should take steps that are necessary and feasible to

improve the clarity and conciseness of financial reporting information so

that the intended users can understand it.

BC2.34 Some users have noted that financial reports sometimes obscure

important information by using convoluted terminology or an

excessively detailed presentation. Accordingly, the draft framework

explains that understandability will be enhanced when information is

clear and concise. Overwhelming users with unnecessarily lengthy

narratives or irrelevant information can decrease the understandability

of financial information and deprive it of its usefulness.

Should additional qualitative characteristics be added?

BC2.35 The boards considered whether other qualitative characteristics should

be added.

EXPOSURE DRAFT MAY 2008—CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

Transparency

BC2.36 Recently, standard-setters, regulators and others have used the terms

transparent and transparency with increasing frequency in describing high

quality financial reporting. The FASB’s mission statement says that

‘accounting standards are essential to the efficient functioning of the

economy because decisions about the allocation of resources rely heavily

on credible, concise, transparent, and understandable financial

information.’ The IASB’s mandate also uses the term in a similar way in

describing its objectives. That raises the question of whether

transparency should be a qualitative characteristic of decision-useful

information.

BC2.37 The boards concluded that transparency should not be added as a

qualitative characteristic of decision-useful financial reporting

information because to do so would be redundant. Transparent

information results from applying several qualitative characteristics that

the draft framework already incorporates, including faithful

representation and understandability.

True and fair view

BC2.38 Some discussions of accounting concepts or principles refer to a true and

fair view or fair presentation. For example, the UK Statement of Principles for

Financial Reporting says:

The concept of a true and fair view lies at the heart of financial reporting in

the UK and the Republic of Ireland. It is the ultimate test for financial

statements and, as such, has a powerful, direct effect on accounting practice.

No matter how skilled the standard-setters and law-makers are, it is the need

to show a true and fair view that puts their requirements in perspective.

BC2.39 The Companies Act of 1947 introduced the notion of a true and fair view

into law in the United Kingdom and the European Union’s Fourth

Directive (Article 2) and Seventh Directive also use the term. Other

countries have used similar terminology in their legislation regulating

business entities. However, none of that legislation defines true and fair

view. The use of the term in legislation generally is in the context of

providing an exception if compliance with accounting standards would

not result in a true and fair view. However, the issue here is whether the

* Accounting Standards Board Statement of Principles for Financial Reporting December 1999,

paragraph 10.

CHAPTER 2 QUALITATIVE CHARACTERISTICS AND CONSTRAINTS OF DECISION-USEFUL

FINANCIAL REPORTING INFORMATION

boards should add true and fair view as a qualitative characteristic of

financial reporting information—not whether the authoritative

literature should provide an exception to the application of accounting

standards in some circumstances.

BC2.40 The IASB Framework, paragraph 46, explains how a true and fair view

applies in the following way:

Financial statements are frequently described as showing a true and fair view

of, or as presenting fairly, the financial position, performance and changes

in financial position of an entity. Although this Framework does not deal

directly with such concepts, the application of the principal qualitative

characteristics and of appropriate accounting standards normally results in

financial statements that convey what is generally understood as a true and

fair view of, or as presenting fairly such information.

BC2.41 The boards agreed with the conclusions reached in the existing IASB

Framework. True and fair view or fair presentation is not a qualitative

characteristic and instead should result from applying the qualitative

characteristics. The boards also observed that for financial reports to

present a true and fair view or to present fairly is the same as faithful

representation, which is already included as a qualitative characteristic.

Credibility

BC2.42 Credibility, which is another term that standard-setters or their

constituents cite as a desirable attribute of financial reporting

information, might be considered an additional qualitative

characteristic.

BC2.43 Among the several definitions of credible in the Oxford English Dictionary

Online, the most pertinent one is ‘worthy of belief or confidence;

trustworthy, reliable.’ Clearly, information will not be of much help in

decision making if users do not consider it worthy of belief. The need for

credibility is the reason that verifiability is a qualitative characteristic.

However, the boards concluded that credibility is not itself a

characteristic of decision-useful financial information. Instead,

credibility is a desired result of the process by which that information is

developed. Whether users consider the information in an entity’s

financial report to be credible will depend heavily on their view of the

trustworthiness of the entity’s management and auditors, as well as on

their view of the relevance of the information in the report and the

degree to which it faithfully represents the underlying economic

phenomenon.

EXPOSURE DRAFT MAY 2008—CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

Internal consistency

BC2.44 Another potential candidate for an additional qualitative characteristic is

internal consistency. The discussion paper Qualitative Characteristics of

Accounting Information published by the Accounting Standards Board of

Japan (ASBJ) discusses internal consistency as follows (paragraph 16):

Internal consistency in this Discussion Paper is different from the term

“consistency” that is referred to in conceptual frameworks issued overseas.

While the latter requires a particular accounting procedure to be applied (for

interim reporting and annual reporting) every period continuously, the

former requires that any individual standard adopted should be consistent

with the existing system of standards.

BC2.45 Thus, the Japanese discussion paper focuses on internal consistency of

financial reporting standards rather than of financial reporting

information. The ASBJ further explained that, in developing financial

reporting standards, internal consistency is needed to infer relevance,

which usually can be demonstrated only after the information resulting

from a proposed standard has actually improved users’ decisions,

especially if the standard pertains to new types of transactions or other

events. Therefore, if the economic environment has not changed

radically, a standard-setter may infer that a proposed standard that is

internally consistent with the existing system of standards that result in

information accepted as relevant should also provide information that is

relevant and useful for decision making.

BC2.46 The boards observed that internal consistency of accounting standards is

desirable and that it should naturally result from developing standards

that are consistent with the same conceptual framework. In addition, if

an existing standard is generally considered to provide relevant

information, it is helpful for standard-setters to be able to infer that a new

standard that is consistent with the existing standard will do the same.

However, the boards concluded that internal consistency should not be

added as a qualitative characteristic of decision-useful financial reporting

information. To do so could impede evolution in the body of financial

reporting standards to improve the decision-usefulness of financial

reports on the grounds that adopting new standards would not result in

internal consistency.

* Discussion Paper in a series titled Conceptual Framework of Financial Accounting, written by

a Working Group on Fundamental Concepts of the Accounting Standards Board of

Japan, September 2004.

CHAPTER 2 QUALITATIVE CHARACTERISTICS AND CONSTRAINTS OF DECISION-USEFUL

FINANCIAL REPORTING INFORMATION

High quality

BC2.47 In its report International Accounting Standard Setting: A Vision for the Future,

the FASB considered high quality a desirable characteristic of both

financial reporting information and financial reporting standards. The

report indicates that application of objectives and qualitative

characteristics should lead to high quality accounting standards, which

in turn should lead to high quality financial reporting information that

is useful for making decisions. That is to say, quality is defined by the

objective and qualitative characteristics of financial reporting

information.

BC2.48 The boards concluded that high quality is achieved by adherence to the

objective and qualitative characteristics of financial reporting

information. High quality information is the goal to which financial

reporting and standard-setters aspire. Therefore, the boards did not add

high quality as a qualitative characteristic.

Other decision criteria sometimes suggested

BC2.49 Constituents have sometimes suggested other criteria for standard-

setting decisions, and the boards have at times cited some of those

criteria as part of the rationale for some decisions. Those criteria include:

(a) simplicity

(b) preciseness

(d) practicability or practicality

(e) acceptability.

BC2.50 To the extent that criteria such as those listed are appropriate for

standard-setters to consider, the boards concluded that they are generally

part of the overall weighing of benefits and costs of providing financial

information. For example, a simpler method may be less costly to apply

than a more complex method. In some circumstances, a simpler method

may result in information that is essentially the same as, but somewhat

less precise than, a more complex method. In that situation, a

standard-setter would include the decrease in precision and the decrease

in implementation cost in weighing benefits against costs.

* Report of the FASB International Accounting Standard Setting: A Vision for the Future (Norwalk,

CT: FASB, 1999).

EXPOSURE DRAFT MAY 2008—CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

How the qualitative characteristics relate to the objective of

financial reporting and to each other

BC2.51 Both boards’ existing frameworks discuss the need to exchange a degree

of one desirable characteristic for an increased amount of another

(trade-offs). For example, the IASB Framework, paragraph 45, says:

In practice a balancing, or trade-off, between qualitative characteristics is

often necessary. Generally the aim is to achieve an appropriate balance

among the characteristics in order to meet the objective of financial

statements. The relative importance of the characteristics in different cases

is a matter of professional judgement.

Concepts Statement 2 discusses necessary trade-offs at greater length, but

the essence of that discussion is the same—that applying judgement is

necessary to achieve an appropriate balance of the qualitative

characteristics. The pervasive constraints on financial reporting may also

be considered when making such trade-offs.

BC2.52 To explain the relationships between the qualitative characteristics, the

boards considered using a chart, such as A Hierarchy of Accounting Qualities

in Concepts Statement 2. However, the boards agreed with Concepts

Statement 2 that the chart is ‘a limited device … for showing certain

relationships among the qualities that make accounting information

useful’ (paragraph 33), and that ‘the hierarchy should be seen as no more

than an explanatory device, the purpose of which is to clarify certain

relationships … ’ (paragraph 34).

BC2.53 Therefore, the boards decided to search for a better way of explaining the

relationships between the characteristics. They considered a chart that

would illustrate how standard-setters might apply the qualitative

characteristics in making decisions about financial reporting issues.

However, they concluded that a chart that illustrated the standard-

setting process would necessarily involve matters that the boards had not

yet addressed in the conceptual framework project, including

recognition, measurement, presentation (display) and disclosure.

For that reason, the boards concluded that to include such a chart in a

chapter focusing solely on qualitative characteristics would be

premature. Therefore, in the discussion paper they preliminarily decided

that the chapter should explain the relationships of the qualitative

characteristics to the objective of financial reporting and to each other.

CHAPTER 2 QUALITATIVE CHARACTERISTICS AND CONSTRAINTS OF DECISION-USEFUL

FINANCIAL REPORTING INFORMATION

BC2.54 In reviewing comments from respondents, the boards noted respondents’

confusion about how the qualitative characteristics relate to each other.

Therefore, the boards proposed that the qualitative characteristics should

be distinguished as fundamental or enhancing, depending on how they

affect the usefulness of information. Regardless of its classification, each

qualitative characteristic contributes to the usefulness of financial

reporting information.

BC2.55 The boards observed that both relevance and faithful representation are

fundamental qualitative characteristics because they work together to

make financial reporting information useful in making decisions.

A depiction that is a faithful representation of an irrelevant

phenomenon is not decision-useful, nor is a depiction that is an

unfaithful representation of a relevant phenomenon.

BC2.56 The boards also concluded that relevance is the quality that should be

considered first. If information about a particular real-world economic

phenomenon is not pertinent to investment or credit decisions, none of

the other qualitative characteristics matters. Accordingly, it would be

inefficient to consider faithful representation, comparability,

verifiability, timeliness or understandability for irrelevant items.

The boards then concluded that faithful representation is the quality that

should be considered next. If the depiction of information about a

relevant phenomenon is a faithful representation of what it purports to

represent, the information will be decision-useful.

BC2.57 Next in the logical progression are the enhancing qualitative

characteristics—comparability, timeliness, understandability and

verifiability. The enhancing qualitative characteristics, either

individually or in concert with each other, cannot make information

useful for decisions if that information is irrelevant or not faithfully

represented. Rather, enhancing qualitative characteristics improve the

usefulness of financial information and should be maximised to the

extent possible.

Constraints on financial reporting

Materiality

BC2.58 Both Concepts Statement 2 and the IASB Framework discuss materiality, and

both define it similarly. However, Concepts Statement 2 describes

materiality as a constraint on financial reporting that can only be

considered together with the qualitative characteristics, especially

EXPOSURE DRAFT MAY 2008—CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

relevance and faithful representation. The IASB Framework, on the other

hand, discusses materiality as an aspect of relevance and does not

indicate that materiality has a role in relation to the other qualitative

characteristics.

BC2.59 The boards concluded that materiality is a pervasive constraint on

financial reporting because it is pertinent to all of the other qualitative

characteristics—not just to relevance. For example, a depiction may

faithfully represent a relevant, real-world economic phenomenon in all

material respects. The boards also concluded that materiality is a

consideration for individual entities and their auditors, not standard-

setters, because whether something is material can be assessed only in

relation to a particular reporting entity’s situation.

Cost

BC2.60 Both boards’ existing frameworks describe the need to balance the

benefits of financial reporting information with the costs of providing it

as a pervasive constraint on financial reporting that standard-setters, as

well as preparers and users of financial reports, should keep in mind.

However, the discussion of benefits and costs in both frameworks focuses

primarily on the difficulty of conducting cost-benefit analyses for

financial reporting requirements.

BC2.61 The boards concluded that the balance between the benefits of financial

reporting information and the costs of providing and using it is a

pervasive constraint on financial reporting rather than a qualitative

characteristic of decision-useful financial reporting information. In the

light of the increased emphasis on the need for cost-benefit assessments

in other areas since the existing frameworks were developed, the boards

also considered whether standard-setters should conduct more rigorous

cost-benefit analyses, perhaps on a quantitative basis.

BC2.62 Standard-setting bodies have long acknowledged the need to ensure that

the benefits of financial reporting information justify its costs. In recent

years, both the FASB and the IASB have attempted to develop more

structured methods of obtaining information about the perceived

benefits and costs of proposed standards. The methods used included

requests—some more formal than others—to constituents to submit

information about the nature and amount of the benefits and costs they

expect to result from a specific proposal. Those requests have resulted in

helpful information and in some situations led directly to changes to

proposed requirements intended to reduce the costs of compliance

without significantly reducing the related benefits.

CHAPTER 2 QUALITATIVE CHARACTERISTICS AND CONSTRAINTS OF DECISION-USEFUL

FINANCIAL REPORTING INFORMATION

BC2.63 The boards observed that the major problem for standard-setters in

conducting rigorous cost-benefit analyses in financial reporting is the

inability to quantify the benefits of a particular reporting requirement,

or even to identify all of them. However, obtaining complete, objective

quantitative information about the initial and ongoing costs of a

requirement, or the failure to impose that requirement, would also be

extremely difficult. Regardless of the difficulty, standard-setters should

endeavour to take into account both the benefits and the costs of

proposed financial reporting requirements.

BC2.64 The boards concluded that the proposed framework should commit

standard-setters to seek information from constituents about their

expectations of the nature and quantity of the benefits and costs of

proposed standards and to consider that information in their

deliberations. In other words, the boards concluded that the improved

framework should go further in the area of assessing benefits and costs

than the existing frameworks do. But the proposed framework stops

short of committing standard-setters to demonstrate that the benefits of

a proposed requirement would justify the related costs. To suggest in the

proposed framework that standard-setters should attempt to conduct

rigorous, quantitative cost-benefit analyses would raise expectations

beyond what is feasible and might make it more difficult for standard-

setters to improve financial reporting.

EXPOSURE DRAFT MAY 2008—CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

Appendix

Proposed amendments to the Framework for the

Preparation and Presentation of Financial Statements

The amendments in this appendix shall be applied for annual reporting periods beginning on

or after DD Month 20XY. If an entity applies this Framework for an earlier period, those

amendments shall be applied for that earlier period. In the amended paragraphs, new text

is underlined and deleted text is struck through.

A1 The heading ‘

Preface’ in the Framework for the Preparation and Presentation of

Financial Statements is amended to Preface to the Framework for the Preparation

and Presentation of Financial Statements.

A2 Paragraphs 9–21 and the headings above them are deleted.

A3 Paragraph 22 and the heading above it are deleted.

A4 Paragraphs 24–46 and the headings above them are deleted.

How will Chapters 1 and 2 fit with the existing IASB Framework?

The US Financial Accounting Standards Board and the International

Accounting Standards Board (IASB) have agreed that each board will finalise the

common framework chapter by chapter. Each board will finalise the chapters

within the context of its current financial reporting hierarchy.

When each chapter is finalised, the relevant paragraphs in the IASB’s existing

Framework for the Preparation and Presentation of Financial Statements will be

withdrawn. This exposure draft proposes that Chapters 1 (the objective of

financial reporting) and 2 (the qualitative characteristics and constraints of

decision-useful financial reporting information) should supersede paragraphs

9–22 and 24–46 of the Framework, which would consequently be withdrawn.

This means that the IASB will use a new framework that will appear as follows:

The Framework (as revised in 20XX) will be:

New

framework =

(20XX)

Add: Preface and Summary [as contained in this exposure draft]

Add: new Chapters 1 and 2 [as contained in this exposure draft]

Add: existing Framework

Less: (paragraphs 9–22 and 24–46)

Add: other necessary consequential amendments (see below)

EXPOSURE DRAFT—CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

A5 Paragraph 83 is amended as follows:

83 An item that meets the definition of an element should be

recognised if:

(a) it is probable that any future economic benefit associated

with the item will flow to or from the entity; and

(b) the item has a cost or value that can be measured with

reliability.*

A6 Paragraph 84 is amended as follows:

84 In assessing whether an item meets these criteria and therefore

qualifies for recognition in the financial statements, regard needs to

be given to the materiality considerations discussed in paragraphs 29

and 30 Chapter 2 Qualitative characteristics and constraints of decision-

useful financial reporting information. The interrelationship between

the elements means that an item that meets the definition and

recognition criteria for a particular element, eg an asset,

automatically requires the recognition of another element, eg

income or a liability.

A7 Paragraph 86 is amended as follows:

86 The second criterion for the recognition of an item is that it

possesses a cost or value that can be measured with reliability as

discussed in paragraphs 31 to 38 of this Framework. In many cases,

…

A8 Paragraph 111 and a heading are added as follows:

Effective date

111 An entity shall apply this Framework (as revised in 20XX) for annual

periods beginning on or after DD Month 20XY. Earlier application

is encouraged. If an entity applies the Framework for a period

beginning before DD Month 20XY, it shall disclose that fact.

*Footnote: Information has the quality of reliability when it is free from

material error and bias and can be depended upon by users to represent

faithfully that which it either purports to represent or could reasonably

be expected to represent.