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Comment Letter - Exposure Draft Conceptual Framework for Financial Reporting to Nordic Standard for Audits of Small Entities
Nov 25, 2015

Comment Letter - Exposure Draft Conceptual Framework for Financial Reporting

Dear Sir

Exposure Draft Conceptual Framework for Financial Reporting

Crowe Horwath International is pleased to respond to the International Accounting Standards Board Exposure Draft Conceptual Framework for Financial Reporting (the “Conceptual Framework”).

We welcome the IASB’s Exposure Draft and we agree with much of the proposals. A new Conceptual Framework is long overdue and the IASB should treat this as a priority project for completion in 2016. The IASB has correctly identified where it needs to “fill gaps”, “update” content and “clarify” guidance. The IASB has recognised in the Exposure Draft the important developing area of presentation and disclosure, where a conceptual foundation is essential both for applying existing standards and for developing revised and new standards.

 

We agree with the overall approach. The IASB is right to give greater prominence to the role of stewardship within the objective of financial reporting. We agree with the reintroduction of the “prudence” concept, although we have some specific observations about the descriptions given in the text. We also have some specific observations about the reporting of financial performance and the conceptual underpinning of the statement of profit and loss as well as the status of the cash flow statement.

 

Our detailed comments are presented in the appendix to this letter.

 

We look forward to seeing the progression and publication of the Conceptual Framework.

Yours faithfully,

David Chitty

International Accounting and Audit Director

 

Appendix – Responses to Questions in the Exposure Draft

Question

Comment

Question 1—Proposed changes to Chapters 1 and 2

Do you support the proposals:

(a) to give more prominence, within the objective of financial reporting, to the importance of providing information needed to assess management’s stewardship of the entity’s resources;

(b) to reintroduce an explicit reference to the notion of prudence (described as caution when making judgements under conditions of uncertainty) and to state that prudence is important in achieving neutrality;

(c) to state explicitly that a faithful representation represents the substance of an economic phenomenon instead of merely representing its legal form;

(d) to clarify that measurement uncertainty is one factor that can make financial information less relevant, and that there is a trade-off between the level of measurement uncertainty and other factors that make information relevant; and

(e) to continue to identify relevance and faithful representation as the two fundamental qualitative characteristics of useful financial information? Why or why not?

We support the additional prominence given to the concept of stewardship and the role that financial reporting plays in enabling users to assess management’s stewardship of the business. We consider this to be one of the primary purposes of financial reporting and consequently we would prefer the concept of stewardship to be given greater prominence via specific inclusion in paragraph 1.2 and the discussion on the objective of general purposes financial reporting.

Whilst we welcome the reintroduction of an explicit reference to prudence we find the description in paragraph 2.18 confusing. As a basic point of English, “neutrality” and “prudence” are different, and to try and merge the two, as is done in 2.18, leaves the description logically incoherent. We also consider that the discussion on asymmetric prudence found in the Basis for Conclusions should be elevated into the main text to give it additional prominence.

We support this proposal.

We support this proposal though consider that the discussion should be extended to include faithful representation as well as relevance. Further discussion in 2.13 should be given as to the circumstances when a high level of measurement uncertainty results in information with little relevance. Without additional detail the Conceptual Framework does not provide enough guidance to clarify when transactions that cannot be measured reliably should not be recognised.

Whilst in broad terms we support the two fundamental qualitative characteristics we consider that greater prominence should be given to reliability in the discussion on faithful representation. In particular the concept of reliability should be discussed within 2.19 and the Conceptual Framework should discuss in greater depth how information that “cannot be determined to be accurate or inaccurate” can be considered reliable.

Question 2—Description and boundary of a reporting entity

Do you agree with:

(a) the proposed description of a reporting entity in paragraphs 3.11–3.12; and

(b) the discussion of the boundary of a reporting entity in paragraphs 3.13–3.25?

Why or why not?

We agree with the description and boundary of a reporting entity.

In our opinion, paragraph 3.6 should be expanded to include the Cash Flow Statement and the Statement of Changes in Equity. Indicating that there could just be one statement of financial performance appears to downgrade the importance of the Cash Flow Statement.

Question 3—Definitions of elements

Do you agree with the proposed definitions of elements (excluding issues relating to the distinction between liabilities and equity):

(a) an asset, and the related definition of an economic resource;

(b) a liability;

(c) equity;

(d) income; and

(e) expenses?

Why or why not? If you disagree with the proposed definitions, what alternative

definitions do you suggest and why?

In our opinion, further work should be done on the definition of financial performance. The current definition (“changes in resources and claims”) does not appear to provide to appropriate conceptual underpinning for the Income Statement and for the view that the statement of profit or loss should be the primary source of information about an entity’s financial performance. In particular the current definition would appear to define financial performance as simply the difference between the opening and closing balance sheet, in our experience this is not consistent with either the way businesses internally assess performance or with the way investors and analysts assess financial performance. The IASB should consider expanding the elements discussed to include revenue and profit. It is only by expanding the elements discussed that the Conceptual Framework will be able to properly define the difference between the Income Statement and the Statement of Other Comprehensive Income.

Question 4—Present obligation

Do you agree with the proposed description of a present obligation and the proposed guidance to support that description? Why or why not?

We agree with the proposed description.

Question 5—Other guidance on the elements

Do you have any comments on the proposed guidance?

Do you believe that additional guidance is needed? If so, please specify what that guidance should include.

See the answer to question 3 above.

Question 6—Recognition criteria

Do you agree with the proposed approach to recognition? Why or why not? If you do not agree, what changes do you suggest and why?

Further clarification should be given to paragraph 4.27. The comment that an obligation to transfer an economic resource “need not be certain, or even probable” could result in contingent liabilities being recognised. We do not believe this is the intention of the paragraph.

Question 7—Derecognition

Do you agree with the proposed discussion of derecognition? Why or why not? If you do not agree, what changes do you suggest and why?

We agree with the discussion of derecognition.

Question 8—Measurement bases

Has the IASB:

(a) correctly identified the measurement bases that should be described in the Conceptual Framework? If not, which measurement bases would you include and why?

(b) properly described the information provided by each of the measurement bases, and their advantages and disadvantages? If not, how would you describe the information provided by each measurement basis, and its advantages and disadvantages?

In broad terms we support the discussion on measurement. However, there are two areas where we consider chapter 6 should be expanded:

The impact of the business model of the relevant measurement basis should be discussed in greater depth and how this might result in the same asset being measured on a different basis for different businesses.

Paragraph 6.32 discusses the problems with fair value measurements in the absence of an active market. Greater discussion should be given as to the circumstances in which the greater degree of subjectivity involved reduces the relevance and reliability (faithful representation) of the information provided and hence the circumstance when fair value is not appropriate. This should be consistent with paragraph 2.13 and the discussion on measurement uncertainty.

Question 9—Factors to consider when selecting a measurement basis

Has the IASB correctly identified the factors to consider when selecting a measurement basis? If not, what factors would you consider and why?

See Q8 above.

Question 10—More than one relevant measurement basis

Do you agree with the approach discussed in paragraphs 6.74–6.77 and BC6.68? Why or why not?

See Q8 above.

Question 11—Objective and scope of financial statements and communication

Do you have any comments on the discussion of the objective and scope of financial statements, and on the use of presentation and disclosure as communication tools?

We welcome the discussion and consider that it provides a useful framework. In particular we welcome the discussion in 7.18 which should be useful to entities in reducing the volume of disclosure. We have the following comment:

Investors value the information provided in the Cash Flow Statement equally to that given in other primary statements, as such the Cash Flow Statement should be referred to in 7.2 (a) as opposed to being referred to indirectly in 7.2 (b).

Question 12—Description of the statement of profit or loss

Do you support the proposed description of the statement of profit or loss? Why or why not?

If you think that the Conceptual Framework should provide a definition of profit or loss, please explain why it is necessary and provide your suggestion for that definition.

Further work is needed on the description of the statement of profit or loss. Paragraph 7.21 states that this statement should be the ‘primary source of information about an entity’s financial performance’ yet financial performance is not defined. As noted above the definition appears to be more based on the difference between an opening and closing balance sheet, which is inadequate.

We suggest that the IASB undertake further work to define financial performance. In particular they should consider whether the statement of profit or loss is considered to be the primary source of information about an entity’s financial performance at present. In our experience entities will often adjust figures when presenting them to analysts to remove items that are not considered relevant to financial performance (IFRS 2 charges being a frequent adjustment). Understanding these adjustments should help the IASB properly define financial performance.

Question 13—Reporting items of income or expenses in other comprehensive income

Do you agree with the proposals on the use of other comprehensive income? Do you think that they provide useful guidance to the IASB for future decisions about the use of other comprehensive income? Why or why not?

If you disagree, what alternative do you suggest and why?

In the absence of a definition of financial performance and a proper conceptual underpinning of the statement of profit or loss it is not possible to conclude on this area.

Question 14—Recycling

Do you agree that the Conceptual Framework should include the rebuttable presumption described above? Why or why not?

If you disagree, what do you propose instead and why?

In the absence of a definition of financial performance and a proper conceptual underpinning of the statement of profit or loss it is not possible to conclude on this area.

Question 15—Effects of the proposed changes to the Conceptual Framework

Do you agree with the analysis in paragraphs BCE.1–BCE.31? Should the IASB consider any other effects of the proposals in the Exposure Draft?

We have no additional comment.

Question 16—Business activities

Do you agree with the proposed approach to business activities? Why or why not?

We have no additional comment other than that made in response to Q8 above.

Question 17—Long-term investment

Do you agree with the IASB’s conclusions on long-term investment? Why or why not?

We concur with discussion given in this area and the conclusions reached.

Question 18—Other comments

Do you have comments on any other aspect of the Exposure Draft? Please indicate the specific paragraphs or group of paragraphs to which your comments relate (if applicable). As previously noted, the IASB is not requesting comments on all parts of Chapters 1 and 2, on how to distinguish liabilities from equity claims (see Chapter 4) or on Chapter 8.

We have no additional comment.