Sir David Tweedie
International Accounting Standards Board
30 Cannon Street
LONDON
United Kingdom
Dear Mister Tweedie,
I think it is very ambitious to create a financial framework that is worldwide accepted and
used as the only framework. The IASB May 2008 exposure draft is a remarkable piece of
consistent thinking through the basics of financial reporting. My remarks should be seen in
this light with the ambition to apply capital provider focus and efficient processes. Scrap
waste, processes and procedures that do not add value to capital providers (OB 5- OB 7).
Comments on the IASB conceptual framework exposure draft May 2008
Built up goodwill
Built up goodwill is in financial reports currently not valuated and not included in the value
of the economic entity. I am not arguing that it should be reported, this would lead to very
high variations in the valuation. However built up goodwill can represent most of the value
of the economic entity. Take for example the stock exchange value of companies or the
net present value of an economic entity. At a point in time this is the value of the company
includes this built up goodwill. However it is never represented in financial presentations.
So if you do not include an item that may well represent most of the economic value why
would you take such an effort in faithful representing other post faithfully. Obligations to
pension funds, valuation of equipment and property, it often takes an enormous,
expensive, effort to faithfully represent. To what extent is this useful for the capital
providers if a very important and very defining item, built up goodwill not represented in the
financial report?(See paragraphs QC2-QC15)
Cash flow
What is of importance when you consider is the cash flow especially of the coming years.
The historical financial figures give a basis for indicating these. However the net present
value is of importance at the moment when an economic entity is for sale. So isn’t it waste
of effort and economic resources of the capital provider if the fair value is calculated every
accounting period when you only need it in case of talks about transition of ownership?
(OB 10-OB 23). I suggest only require cash flow representation in those cases where
management and owners of the economic entity are the same.
Who is it for? Management is owner vs management is ‘agent’
I suggest the board to consider to try to keep the focus on the user throughout the
framework. So the right information at the right moment to the right person. Of course the
differences are high between the user groups but I think that an important thing has to be
considered which are ownership and owner the same person or persons. For example if
most of the management team of a company has all the shares why so much effort
calculating the fair value? As part of the management they should have the information for
calculating the fair value of the company and the insight if the money of the capital
providers is well spent. I think the board should consider allowing only cash flow
representation in the financial reports.
In the FASB statement of financing accounting already a distinction is made between
business and non business organizations. I think parallel to this in the framework a
distinction should be made in the IASB framework but now between economic entities of
which the management and owners are the same and entities in which owner and
management are not the same. The point is that you have to be stricter in reporting if
management and owners are not the same because you have to check carefully people
who deal with your money. However for management that owns the entity very strict
reporting would be waste because these know the financial information (or should)
because it is their daily business.
The framework should be directive for accounting standards. The board indicates that it
does not want to overrule existing standards. I consider this to be a smart way to prevent
resistance against the framework in an early stage. I suggest to the board to give the
adapted framework on basis of these comments a stricter status. Other ways it runs the
risks of become ‘paper tiger’ because in the end it comes all down to the accounting
standards and the governmental regulations. Therefore I suggest the board to commit
parties and accounting organizations to make all standards consistent with the framework
within a limited timeframe, say 10 years.
Comments on exposure draft May 2008
In the exposure draft there is a lot of attention for concepts with which financial reports can
be made and on which these can be based. However there is not a focus on the
information needs of the user. These need information about the fair value at the moment
of considering buying an economic entity. In many cases for management owned entities
this may be
My suggestion; actively involve users of the information in the process. In fact some of
them organizations or organisations, such as associations of stock investors, should be
member of the development teams. This way the user perspective should be more visible
and worked out in both the frame work. What users need, can be more specifically defined
and also what users do not need and use can be defined. Waste, not useful parts of the
financial reporting can be skipped. For example why determine the fair value of a company
when you do not want to sell the company anyway and the stocks are not publicly traded?
(S2) Capital providers are selected as primary user group. Logical, these have the highest
risk in misrepresentation. The problem with this objective is the question is the reliability
with which the financial information can be represented? To what extent is this objective
reachable? There are some doubts and different valuation methods that result in very
different values. To name some of these: Should I value my assets against historical costs
or should I use market value, and what that market value than be? Investments are these
costs or assets? If these are assets how should these be valued? And reservations for
pension funds, Should these be based on pensions with inflation correction or without?
And if inflation correction is used what inflation percentage should be used?
(S3) I just mentioned the large fluctuations in values of assets. For materiality this may
mean that in one reporting system the same item can be material whilst in others it is not.
Part of the cost of the information is the possible discussion on what basis it should be
valued. I think the term cost is too limited and only used here as a selection criterion for not
researching some things. I suggest here that the board considers the following:
If certain aspects are very complex and it is very hard to acquire the right figure. It should
be possible to make realistic estimations accompanied with that made the estimation
under what assumptions and at what moment. The financial statements should include the
person who made the assumptions and the person who made them and the moment the
estimation has been made.
The risks should be clearly communicated to the users of the information. Relate to labels
on nutrition products. The main aspects for the health of the users are indicated in a
standardised format that cannot be unnoticed by the potential buyer. I think entities that
need to do financial reporting should strive to such clarity for the potential buyers of part of
their entity.
(S 4) Here I would add to faithful representation that if there are significant differences form
different kind of valuations these should be mentioned in the financial figures.
I would add to this that it is important for financial standard development to include groups
of users or representatives of these in the developments of these. Especially the
discussion on the details of the standards as these are developed should include the
reporting information users’ perception and think through the consequences for the use of
the standard in practice.
(S 6) I think is right to identify understanding ability of the information for the users as an
important Issue. Use the associations for stockholders and involve especially non
professional small investors in the standardisation. See also my comments on S5. For
standardisation I suggest to loot at examples of standardised labels for nutrition value. To
a very detailed level these may be standardised. Colors, lettertypes etc. For financial
reports it this is standardised it probably improves comparability because comparable
figures are on the same part of the page.
(S 7) I suggest to the board to add here realism as a pervasive constraint, which can be
seen as a combination of the faithful representation and cost constraint. Furthermore
efficiency should be mentioned. The consequences of the strict regulation on financial
reporting are that cost to make the financial statements have risen significantly. It is the
challenge to minimize the cost involving financial reporting while being understandable and
faithful to the stakeholders. I suggest here to look at principles of lean manufacturing now
applied for financial reporting; scrap waste (what is the added value for the stakeholder?)
and standardise are two useful concept to be applied in my opinion.
(OB 1-OB 19) I think that the board should consider defining a scope for the framework ‘In
der Beschränkung erkennt sich der Meister’ Goethe. I translate this as ‘in the limitation the
expert is known.’’ Furthermore some depending on the size and the risks in industries
differences per industry may be added. Of course this can also be worked out in the
financial standards that hopefully will in time clearly relate to the framework. However I
suggest to the board to give a basis for differentiation. Number of employees (Full Time
Equivalent), and balance sheet total may be basis of the differentiation.
(OB 3) I suggest here to include realistic information and I suggest to include information
on the differences in valuations methods. Different valuation methods and differences in
assumptions and market expectations are responsible for such a large variance that this
should be very clear in the financial statements. In OB 25 the framework addresses
management explanations. I suggest to make this more concrete and verifiable. Very
remarkable financial situations such as not having income just spending money, such as
happened during the internet hype should be explained by the management.
(OB 5) I suggest to include ‘..those with a potential claim on the entity’s resources.’
Because these have to make the decision if they want to be claimant of the entity. The
financial statement should be useful for this decision.
I suggest to the board to take into account the differences in back ground and education
that exist individual capital providers. I therefore suggest to communicate the aspect of the
financial report that may well have large impact very clearly. For example in the internet
hype companies with virtually no income were sold to stockholders…Financial statements
and the standard to make them should be very clear and strict about the fair value of the
economic entity at the moment of potential sale. So that misunderstanding and misleading
is harder.
(QC 1) As mentioned in the comments on chapter 1 I think that realistic representation is a
very important constraint. Not too low and not too high.
(QC 2) I think in financial reports you only find a description of the past. May be some
economics effects of the past still occur. I think the text in the framework should prevent
suggesting to give information on the future.
(QC 3 – QC 4) I think, the management, the stewards of the capital providers have the
best information position and should use this to inform the capital providers with relevant
information to their best abilities.
I think the board should consider formulating the responsibility of management to supply all
Relevant information in the text of the framework.
(QC6) I refer to my comments on QC3. Management has an import responsibility here.
I agree with the text. However it should be noted that a material error margin may be
thousands of dollars. In other words the error margin is trusted to the management.
This is clear
(QC 10) I consider the text for this item ambiguous. On the one hand absence of bias and
on the other hand able to influence….. I suggest giving management the role of giving the
information as if the entity is their own. I think this text should start with “For faithful
representation it is necessary to disclose explicit the degree of uncertainty associated with
the financial figures.
I think it is wise to first consider relevance. I suggest to the board to consider giving
management a role in this. They have access to most detailed analyses.
(QC 16- QC 21)I suggest to the board to consider prioritizing these enhancing
characteristics. I suggest verifiability, timeliness; understand ability and comparability as
order of priority.
I think this is important but not primarily. First you need to know is the information is right
and on time. So verifiable and not too late to matter and then of course you have to
understand the information…..
(QC 22) All information in financial statements is about things that have been. The future is
always uncertain. However of course it is possible to wait very long to provide certain
financial statements. In that sense timeliness matters. I suggest to the board to formulate
in the framework requirements about what time lap is allowed between the end of the
accounting period and the presentation of the financial statement.
(QC 23) I think that involving users of the information is especially for this point. The
standard for understand ability is if the stockholder (professional and non professional) can
understand it.
If you do not understand the financial report do not invest. That should be made clear to
the potential stockholders.
(QC 25) Yes indeed relevance and faithfulness precedes these demands.
As mentioned in my comment on Q16 I have the opinion that there is an priority in these
enhancing characteristics. I suggest to the board to reconsider QC26
I Suggest to take into account the constraint realistic. Not too high and not too low
estimations and assumption. This opposed to the conservative constraint that is used in
(Q33) I would refrase this. Financial reporting is there to inform stakeholder in an entity to
about how it is doing in its market environment.
(QC 32)I suggest to omit the text ‘free from error’ because materiality is about relative
small amounts which will probably be given lesser attention from management and
controlling staff (internal and external)
(QC 33) I suggest to the board to leave the application of the cost principle to management
of the entity. They are expected to manage the entity as if it were their own. This includes
prevent wasting money on book researches that just go into the history of the company.
Better invest in a market research to improve the entities market approach. If there are
indications of fraud information should be given to authorities for further investigation.
My answers to the ISAB questions
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?
Yes, I agree. I think that this decision in the framework will in practice and if adopted in
financial standards that are basis of law of a country will have large consequences. The
continuity of the entity will be an issue also stockholders. I already mentioned flip flop
stockholders, those who have a very short time own interest in the stock and try to
optimize the effect for themselves. I think the entity perspectives lessens their influence
and I suggest to the board to think through the entity paragraphs more and also give
advises as to how these aspects can be implemented in the standard.
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?
Yes I agree. Why would the claim of a supplier be less of interest than a claim of a stock
holder? Both supply resources that are important for continuation of the entity. I would
suggest to the board to give suggestions to the organisations that make financial
standards and laws on financial reporting that will hopefully be based on the framework.
One suggestion to these groups that I suggest is involve usergroups, for example
European, American trade organisation and organizations of (long term) investors in the
making of the financial standard.
A point BC 1.14 mentioned distinction of the role of managers and the role of investor in
the company. Ownership in financial terms and management are not in the hands of one
person. So the interest of owner and manager are not aligned. Here the basis for Enron
and other disasters lies. I think it is important that it is acknowledged and well
communicated towards users of accounting information that there is a chance that figures
are not right.
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
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.
I partly agree but I think it is too broad formulated and a scope is missing. First I think that
capital providers should not base their decisions on only the financial reports of an entity
because the information says something about things that has been. It is however of help
because it is clear what happened in the past so if conditions (economic, management of
the company) is stable one has an indication that the results can be extrapolated. This
may then guide the decision making of capital providers.
I suggest to the board to hint to using also other sources of information and formulate this
objective as ‘the information in the financial reporting makes clear the past financial
performance of the entity. This is of help for capital providers to make their decisions
whether or not and how much capital they will provide for this economic entity.
I suggest for the scope ‘give the basic financial information. Not financial analysis or
statistic analysis.
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?
Yes I agree
(b) Comparability, verifiability, timeliness and understand ability are
Enhancing qualitative characteristics? (See paragraphs QC17–QC35
and BC2.25–BC2.35.) If not, why?
I agree that comparability, verifiability, timeliness and understandabilty are enhancing
qualitative characteristics. I furthermore to add realistic presentation as an enhancing
characteristic.
I think it is wise to prioritise these and make the following priority suggestion:
1. Verifiability
2. Timeliness
3. Understandability
4. Realistic presentation
5. Comparability
My reasoning for this prioritization is that if figures are not verifiable they have no meaning
whatsoever. In the same conditions each other person should reach the same results.
Then Timeliness, because of if results are published after an extensive period say more
than 1.5 years it is really about history. Then Understandability because if the figures
cannot be understood they cannot be used only than by the people who organized these
figures.
Then I add realistic representation, by which I mean that the risks involved should be
clearly mentioned at least qualitative. For example reservations for pensionfunds can be
with or without a factor for consumer price increase. The consumer price increase
compensation is often not a hard condition in the agreements with the pension funds. It is
realistic to add this information and distinguish between the hard obligations and softer
obligations.
On the last place I mentioned comparability because only with reasonable certain figures a
comparison can be made with other economic entities. The other enhancing
characteristics have to be met if comparability makes any sense.
(c) materiality and cost are pervasive constraints? (See QC29–QC32 and
BC2.60–2.66.) If not, why? Is the importance of the pervasive
constraints relative to the qualitative characteristics appropriately
Represented in Chapter 2?
I refer to my answer about materiality and cost at chapter 2. I think that the way these are
defined now will lead to introduction of many subjective decisions, which, if trustful
relations with capital providers is violated will lead to very costly researches.
Trustworthiness has to be taken into account. Furthermore the efficiency of financial
reporting has to be taken into account. In working out the framework into standards the
timing of the information needed by the capital provider should be considered.
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?
I think these are properly defined. I think that they can be consistently understood but it all
comes down to how these are implemented in the financial standards and regulations. I
think the board should acquire a directing role in the standardizations processes that will
ideally be based on the framework.
(ii) Are the components of the fundamental qualitative
Characteristics appropriately identified and sufficiently
Defined for them to be consistently understood? If not, why?
Yes.
3 Are the enhancing qualitative characteristics (comparability, verifiability,
Timeliness and understand ability) appropriately identified and sufficiently
Defined for them to be consistently understood and useful? If not, why?
I refer here to my remarks on the question on enhancing characteristics on chapter 1. I did
some suggestions there to make the enhancing qualitative characterises more useful.
Especially realism a concept that I suggest to introduce and work out. There is a risk
capital providers run when supplying their resources. Accept it and make capital providers
aware of this so that they keep their eyes open.
4 Are the pervasive constraints (materiality and cost) appropriately identified
and sufficiently defined for them to be consistently understood and
useful? If not, why?
I think that there is room for improvement especially with practical application in mind. I will
try do give the board some suggestions.
Materiality has in itself the problem that it is subjective. Because how can you objectively
state that a certain thing amount will not have any relevant impact on the entity. Will that
be a percentage of the balance total? What percentage will it be and does it vary with
variations of balance sheet total? In short what are the objective criteria to decide about
materiality? I suggest the board to consider a percentage of the balance sheet total and
mention this in the framework, so that it will give direction on dealing with this in the
financial standards and regulation that will hopefully be based on this framework.
Costs is has also the draw back that it is not subjective measureable whether or not the
cost weigh out the impact and benefits of the financial information is gathered. Who
decides where to stop researching? There is al link here to the trust that is given by capital
providers to management and organisations that check the financial reporting. I think the
management and checking organisations need to be given trust until there are indications
that they misuse this. Then capital providers should be able to take measures such as
demanding further research.
So in situations in which there is lack of trust cost of the expenses of the checking of the
financial figures will rise, because more effort has to be put in it.
I furthermore suggest to the board to consider introducing an extra concept here namely
efficiency. Financial results should be gathered as efficient as possible and principles of
lean manufacturing should be introduced. I suggest to lay in the framework the basis to do
this. It would mean focus on the customer; the capital provider, scrap waste; so do not
make reports that do not add value in the decision making of the capital providers and
strive to zero defects and give responsibilities to the people alongside the ‘manufacturing’
to stop if they see quality problems.
Kind regards,
Leo Oosterveen
Student Part Time MBA 6 at Nyenrode Business Universiteit