Improving the conceptual framework – is that reliable enough?

As we discussed here, the IASB has published for public consultation proposals to improve the Conceptual Framework for Financial Reporting, with comments to be received by October 26, 2015.

Among much else, the IASB proposes adding the following new language to the existing discussion of what makes financial information relevant:

  • “One factor affecting the relevance of financial information is the level of measurement uncertainty. Measurement uncertainty arises when a measure for an asset or a liability cannot be observed directly and must instead be estimated. The use of estimates is an essential part of the preparation of financial information and does not necessarily undermine its relevance, but the estimate needs to be properly described and disclosed.
  • An estimate can provide relevant information, even if the estimate is subject to a high level of measurement uncertainty. Nevertheless, if measurement uncertainty is high, an estimate is less relevant than it would be if it were subject to low measurement uncertainty. Thus, there is a trade-off between the level of measurement uncertainty and other factors that make information relevant. For example, for some estimates, a high level of measurement uncertainty may outweigh those other factors to such an extent that the resulting information may have little relevance. On the other hand, a high level of measurement uncertainty does not prevent the use of an estimate if that estimate provides the most relevant information.”

For background, some respondents to the IASB’s earlier discussion paper expressed the view that the conceptual framework should define “reliability” as a characteristic of useful financial information, rather than “faithful representation,” as it currently uses. Prior to changes in 2010, the framework did actually refer to “reliability” – the IASB made the change, recounts the basis for conclusions to the new proposals, because of “a lack of a common understanding of the term reliability. In particular, many seemed to equate reliability solely with information being verifiable or free from material error (in other words, having a tolerable level of measurement uncertainty). The term reliability was in fact intended to describe more than just verifiability and freedom from material error.” Still, many continue to believe that “the qualitative characteristic of faithful representation does not act as an effective filter to identify the types of information that should be included in financial statements. It would allow the recognition of items that cannot be measured reliably.”

Many also think “reliability” is “clearer and better understood” than “faithful representation.” That’s true of course, in plain language terms, but the way in which it’s clearer and better understood would seem to be potentially misleading, if used in the context of financial reporting. For various reasons, the IASB decided that “reliability” doesn’t convey anything that’s not better reflected in the current terminology. However, because the evidence suggests “that many respondents equate the word reliability solely with a tolerable level of measurement uncertainty,” it decided to provide the enhanced discussion cited above.

As with other aspects of the conceptual framework, the way in which these principles work their way into individual standards might not necessarily seem very consistent. For example, an entity doesn’t recognize a provision under IAS 37 if it can’t make a reliable estimate of the amount of the obligation, although the standard indicates that these cases will be “extremely rare.” However, in contrast, the forthcoming IFRS 9 requires measuring all equity instruments at their fair value, and (unlike the current IAS 39) doesn’t provide any exception for unquoted equity instruments for which a fair value can’t be reliably measured. The IASB concluded: “measuring all equity instruments at fair value, including those that are currently measured using the cost exception in IAS 39, meets the criteria in the Framework for information to be reliable (which I suppose we might now better read as “to be faithfully represented”) if appropriate measurement techniques and inputs are employed.” As the IASB argues it there though, it’s not clear why that wouldn’t be the case for all provisions under IAS 37 too. Even if a provision has severe measurement uncertainty attached, isn’t it better to allow users to focus on the item by recording an estimate, and then giving them enough information to engage with the extent of uncertainty underlying that estimate?

The IASB rejects the idea “that anything can be faithfully represented if sufficient disclosures are given,” and we can likely see how this statement applies, for instance, to something like the costs of environmental depletion: because no financial reporting basis has evolved for grappling with and representing those items, any individual entity’s attempt to determine its own accounting policy and to measure liabilities and costs within that policy would likely have limited relevance to many users. But for items where a formal standard has been developed and issued, you might take the view that exceptions based on reliability of measurement should be entirely absent….

The opinions expressed are solely those of the author

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