Financial Reporting
Issues
James Leisenring, FASB Senior Advisor
The views expressed in this presentation are my own and do not necessarily
represent official positions of the Financial Accounting Standards Board.
Official positions of the FASB Board are arrived at only after extensive due
process and deliberations.
The Vision
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...one single set of high
quality global standards...
...used on the global
capital markets.
Financial Reporting Issues
Benefits of Global Standards
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• Fundamental to getting to a high-quality global
reporting system
• Attracting investment through transparency
• Reducing the cost of capital
• Increasing world-wide investment
• Reducing costs
Financial Reporting Issues
Benefits of Global Standards
Critical Factors
Must in fact adopt and not
adapt IFRS
• Some (most?) adapt not adopt
• Some such as Europe have not adopted
but decide whether to adopt standard by
standard
Financial Reporting Issues
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Benefits of Global Standards
Questions
What does “used” mean:
• If application of the standards is not
consistent, are the benefits illusory?
• If application is not consistent, is the
cost of conversion in the USA worth it?
Financial Reporting Issues
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Benefits of Global Standards
Questions
Do we agree on what is meant by a
high-quality accounting standard?
• FASB/IASB Research Conference
• My view
Financial Reporting Issues
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Attributes of a High-Quality Standard(1)
1. Be consistent with the guidance provided by an underlying
conceptual framework.
2. Avoid or minimize alternative accounting procedures,
explicit or implicit, because comparability and consistency
enhance the usefulness of information.
3. Be unambiguous and comprehensible so that the standard
is understandable by preparers and auditors who must
apply the standard, by authorities who must enforce the
standard, and by users who must deal with the information
produced by the standard.
4. Be capable of rigorous interpretation and application so that
similar events and transactions are accounted for similarly
across time periods and among companies.
(1) A
Vision of the Future (FASB 1999)
Financial Reporting Issues
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Attributes of High-Quality Standards
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Each attribute serves to promote comparability
• Application of standards leads to consistent
conclusions across varieties of transactions
• Explicit alternatives not comparable
• Implicit alternatives are the result of ambiguity and
inability to apply and interpret consistently
Financial Reporting Issues
Does the IASB Agree with These
Attributes of High-Quality?
1.
“IFRSs are based on the Framework, which addresses the concepts underlying the
information presented in general purpose financial statements. The objective of the
Framework is to facilitate the consistent and logical formulation of IFRSs.”
(Preface to IFRSs, paragraph 8)
2.
The IASB’s objective is to require like transactions and events to be accounted for
and reported in a like way and unlike transactions and events to be accounted for and
reported differently, both within an entity over time and among entities. Consequently,
the IASB intends not to permit choices in accounting treatment.”
(Preface to IFRSs, paragraph 13)
3.
Although a single economic phenomenon can be faithfully represented in multiple
ways, permitting alternative accounting methods for the same economic phenomenon
diminishes comparability.
(IFRS, QC 25)
4.
One of the most important reasons that financial reporting standards are needed is to
increase the comparability of reported financial information.
(IFRS, BC3.33)
Financial Reporting Issues
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Does the IASB Agree with These
Attributes of High-Quality? (cont.)
Question
ARE “principles-based” standards unambiguous?
• What do we mean by principles-based?
• What do IASB constituents mean?
• Does principles-based allow implicit alternatives?
In my view what is often meant by principlesbased contradicts any notion of comparability.
Financial Reporting Issues
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Convergence
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• Memorandum of Understanding (Roadmap)
• Focus on major projects on agenda
• Don’t try to address every reconciling item
• Don’t try to converge inadequate standards
Financial Reporting Issues
MOU Projects
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Business Combinations (completed)
Consolidations
Derecognition
Fair Value Measurements
Liability and Equity Distinctions
Financial Statement Presentation
Postretirement Benefits
Revenue Recognition
Leases
Financial Instruments
Intangible Assets (not on agenda)
Financial Reporting Issues
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Framework Consequences
• Boards to date have not expended the
resources to resolve the conceptual issues
inherent in the MoU projects
Risk of very inconsistent answers
Has been a major impediment to project
resolutions
Financial Reporting Issues
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Objective of Financial Reporting
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• “The objective of general purpose financial reporting is
to provide financial information about the reporting
entity that is useful to existing and potential investors,
lenders, and other creditors in making decisions about
providing resources to the entity. Those decisions
involve buying, selling, or holding equity and debt
instruments, and providing or settling loans and other
forms of credit.” (OB-2)
• Seems to be fundamental agreement if one accepts:
 General purpose financial reporting
 Not management accounting
 Not regulatory accounting
Financial Reporting Issues
Qualitative Characteristics
Fundamental qualitative characteristics
• Relevance (Information capable of making a
difference) If not material, it does not make a
difference.
• Faithful representation (Faithfully represents
what it purports to represent.)
Neutrality
Completeness
Financial Reporting Issues
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Qualitative Characteristics
Enhancing qualitative characteristics
• Comparability
• Verifiability
• Timeliness
• Understandability
Cost as a pervasive constraint.
Financial Reporting Issues
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Qualitative Characteristics
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• Seem to have basic agreement now on the
fundamental and enhancing characteristics of
decision-useful information.
• Boards also have said comparability is an
essential objective of standard setting.
 “One of the most important reasons that reporting
standards are needed is to increase comparability
of reported information” (QC-BC 3.33)
Financial Reporting Issues
Qualitative Characteristics
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But do we agree on what we mean
by comparability?
• Is historical cost comparable?
• Identical assets (which produces comparability?)
 Account for these the same
 Account for these as used (or intended to be used)
• Does a “business model approach” enhance or
impair comparability?
Financial Reporting Issues
Impediments to Achieving Progress
on Standards
Selected Conceptual Framework Issues
• Definition of control
• Asset/Liability definitions
• Unit of account issues
Illustrate these issues in terms of selected MOU
projects
Financial Reporting Issues
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Conceptual Framework Issues
Definition of Control
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As used in asset definition
As used in consolidation
As used in revenue recognition
Questions about Control
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Does a forward contract to acquire an asset
convey control of that asset?
•
Does an option to acquire an asset convey control
of that asset?
•
Do we consistently ask “control what“?
Financial Reporting Issues
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Conceptual Framework Issues
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Asset/Liability Definitions
• Where is the focus with respect to an asset:

Present right
 A right either exists or does not exist

Probable benefit (cash inflow)
 The outcome of having a right (which could be zero)

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Contingent asset
Where is the focus with respect to a liability:

Present obligation
 An obligation either exists or does not exist

Probable sacrifice (cash outflow)
 The outcome of having an obligation (which could be zero)

Contingent liability?
Discussions of contingent assets/contingent liabilities are really
discussions about arrangements with uncertain outcomes
Financial Reporting Issues
Conceptual Framework Issues
Asset Liability Definitions
Observations
• Some virtually certain in or out bound cash flows are not
assets or liabilities
• “Risks and rewards” are not liabilities and assets; They are
the results of having assets and liabilities
• Risks and rewards do affect the measurement of both
assets and liabilities
• We don’t know what to do with forward (executory)
contracts that appear to meet definitions of assets and
liabilities
 Are forwards just “contingent” assets and liabilities?
Financial Reporting Issues
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Conceptual Framework Issues
Questions about Assets and Liabilities
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Can writing an option (by definition, a liability)
result in an asset?
• Can one have a liability without any present
obligation if non-payment is sufficiently
consequential?
• Can one have a liability if they contract to refrain
from a given activity or did one just sell an
unrecognized right?
Fundamental: Can one have a liability if presently
obligated to deliver an equity instrument rather than
an asset?
Financial Reporting Issues
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Conceptual Framework Issues
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Questions about “Unit of Account”
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What does it mean?
 1 x or 1,000 x
 A group of x + y
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Does the “unit of account” notion only affect
measurement or also recognition?
If x and y are combined, must both meet the
definitions of assets or liabilities to be recognized?
What is meant by account for the “whole contract”?
Financial Reporting Issues
Conceptual Framework Issues
Questions about “Unit of Account”
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Is linkage (an undefined term) another unit of
account issue?
 Combine contracts only with the same counterparties or
with different counterparties?
 Combine contracts only if entered into contemporarily?
•
Is a linkage notion operational?
Financial Reporting Issues
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Conceptual Framework
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Observations about Framework
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One phase of the Conceptual Framework project is
intended to address measurement attributes and
measurement issues
 Measurement of assets is of course controversial
 Measurement of liabilities seems to be impossible
•
We seldom really measure anything, we make
calculations
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Financial Reporting Issues
Best estimate
Present value of expected cash flows
Conceptual Framework
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Implications on Present Agenda of Framework
Uncertainty
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Insurance accounting
Consolidations
Postretirement benefits (Pensions)
Revenue recognition
Liabilities and equity
Leases
Financial Instruments
Derecognition
Financial Reporting Issues
Conceptual Framework
Implications of Framework Uncertainty
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Insurance accounting
 Written options are assets
 Expected distributions are liabilities
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Consolidation based on control
 Ability to be in control
 Actually controlling
 Perpetuation of control
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Pensions—Is there a unique definition of liabilities
to employees?
 Liability as a result of future service and final pay
 Liability for unvested obligation
Financial Reporting Issues
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Conceptual Framework
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Implications of Framework Uncertainty (continued)
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Revenue recognition
 Unit of account: Identification of performance obligation
 Liability definition: Satisfaction of performance
obligations—when the customer obtains control of that
good or service
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Why does the criterion for revenue recognition focus on
the customer (the transferee) to determine the seller’s
(the transferor) accounting?
Liabilities and equity
 Liability definition: Is the obligation to deliver an equity
instrument a liability?
Financial Reporting Issues
Conceptual Framework
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Implications of Framework Uncertainty (continued)
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Leases: Basic right of use model (unconditional right
and obligation)
 Do lessors have a performance obligation under a
right of use model beyond delivery of the underlying
asset?
 Is the distinction between the lessor derecognition
model and the performance obligation model
appropriate?
 Are performance obligations of lessors defined
consistent with the revenue recognition project?
Financial Reporting Issues
Conceptual Framework
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Implications of Framework Uncertainty (continued)
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Financial Instruments
 Business model—recognition
 Business model—measurement
 Business model—presentation
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Measurement consequences of multiple attributes
 Impairment
 Complexity
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Hedging
 Fair value hedges
 Cash flow hedges
Financial Reporting Issues
Conceptual Framework
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Implications of Framework Uncertainty (continued)
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Derecognition Issues
 Why don’t we derecognize when definitions of assets
and liabilities are no longer met?
 Do we insist on “stickiness” because we think “risks and
rewards” are assets and liabilities?
 How important are “linkage” issues?
 Why do we conclude forwards and options are more
important for derecognition than for recognition?
 Why would written puts prohibit sale except in revenue
recognition?
Financial Reporting Issues
Conceptual Framework
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Lack of concentration on the Framework has been my
biggest disappointment and frustration during my nine
years at the IASB.
• Led to serious inefficiency in standard setting
• Inconsistent answers in different projects
Lack of attention to the Framework also seems to
have perpetuated misunderstandings about the
present Framework particularly in segments of the
academic community.
Financial Reporting Issues
Conceptual Framework
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Misunderstandings of Both IASB
and FASB Frameworks
Basic conclusion as to conceptual
primacy of assets and liabilities
• Thought to be a balance sheet view
• Implies there could be an income statement
view
• Implies the basic conclusion resolves
measurement which must be at fair value
Financial Reporting Issues
Conceptual Framework
Framework is essential:
1. To resolve accounting debates in a consistent
manner
2. To defend accounting standard-setting
process as in fact neutral
3. To achieve “principles-based standards”
4. Alternatives suggested just won’t work:
• Consensus
• Compromise
• Consequences
Financial Reporting Issues
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Credit Crisis
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Lessons I wish we had learned:
• Accounting can’t cause losses
• Accounting can’t cure the fact that losses have
occurred even if ignored
• Objectives of regulators are not consistent with
objective of financial reporting
• Information if current is pro-cyclical
• Circumstances like the past few years are in part a
crisis of confidence
• Undermining confidence in financial reporting with
bad accounting only makes things worse
Financial Reporting Issues