On March, 29th, 2018 the IASB published its “Conceptual Framework for Financial Reporting”, which replaced the former Conceptual Framework (2010). The Conceptual Framework (2018) changes the definition criteria of assets and liabilities and waives separate recognition criteria for assets and liabilities. For the first time, the Conceptual Framework (2018) includes basic considerations regarding the derecognition of assets and liabilities, the selection of an appropriate measurement basis for assets and liabilities and the delineation of profit or loss against other comprehensive income.
I INTRODUCTION
On March 29th, 2018, the IASB finalised its Conceptual Framework project after more than 10 years. After finishing the joint Conceptual Framework project undertaken with the FASB which leads to the intermediate step of the Conceptual Framework (2010), the IASB relaunched the project alone. The next steps were 2013 the publication of the Discussion Paper “A Review of the Conceptual Framework for Financial Reporting” (DP/2013/1) and 2015 the publication of the Exposure Draft “Conceptual Framework for Financial Reporting” (ED/2015/3). The publication of the final “Conceptual Framework for Financial Reporting” (in the following CF (2018)) was accompanied by “Basis of Conclusions” and “Amendments to References to the Conceptual Framework in IFRS Standards”. The structure of the CF (2018) follows a logical order. This could be demonstrated by the fact, that the objective and the qualitative characteristics of useful financial information which are included in the first two chapters of the CF (2018) form the basis for deducing the delineation of the reporting unit (including the considerations regarding consolidated and separate financial statements), the recognition, the derecognition and the appropriate measurement basis for assets and liabilities, and the distinction between profit or loss and other comprehensive income.
Table 1: Connection between objective and qualitative characteristics of useful financial information and the further contents of the CF (2018)1
In the following, the article shows the significant changes of the CF (2018) in comparison to the preceding ED/2015/3 and the therefrom resulting potential effects.
Source: Kirsch, Deutsche Steuer-Zeitung 2018, p. 620.
II SIGNIFICANT CHANGES OF THE CONCEPTUAL FRAMEWORK (2018) IN COMPARISON TO ED/2015/3
1 Qualitative characteristics of useful financial information
Both, the distinction of the qualitative characteristics in fundamental and enhancing and all of the single qualitative characteristics remain unchanged to the ED/2015/3 and also the CF (2010). The reference of the neutrality to a special kind of a prudence principle, named as “cautious prudence”,2 described as the exercise of caution when making judgements under conditions of uncertainty, is explicitly confirmed by the CF (2018). In deviation to the ED/2015/3, the measurement uncertainty is identified as one factor in the context of the faithful representation,3 and not like in the ED/2015/3 as a factor in connection with the relevance.4 Measurement uncertainty arises, when monetary amounts in financial reports cannot be observed directly and must instead be estimated.5 The reactions to the ED/2015/3 lead to that change in classification. Measurement uncertainty makes information less verifiable. Even in the case that information is subject to a high level of measurement uncertainty, it can still be relevant.6
Compare for the delineation against the asymmetric prudence CF (2018). chap. 2.16. and in addition Wagenhofer, IRZ 2014, pp. 265–266.
See CF (2018). BC 2.55 sent. 1.
See ED/2015/3. chap. 2.12–2.13.
See CF (2018). chap. 2.19 sent. 1.
See CF (2018). BC 2.48 a) sent. 1 and 2.48 c) sent. 1.
2 Recognition of assets and liabilities
The definitions of assets and liabilities are identical with those included in the ED/2015/3. For example, an asset is already existent if a present economic resource is controlled by the entity as a result of past events.7 Just as in the ED/2015/3, the definitions of the equity, income and expenses are based on the definition of assets and liabilities.8 Although the CF (2018), like the preceding ED/2015/3, waives separate recognition criteria for assets and liabilities, the CF (2018). chap. 5 discusses in a detailed manner under which conditions the recognition of an item that fulfils all criteria for an asset or liability would not provide useful information and should therefore not be recognised in the balance sheet. With reference to the fundamental qualitative characteristics the IASB concludes that assets or liabilities whose existence is uncertain (e.g. the right of getting a compensation for an entity’s alleged act of wrongdoing if it is unclear whether the act occured, or the entity committed it or how the law applies9), or the probability of inflows or outflows of economic benefits is very low,10 or the assets or liabilities are subject to a high degree of measurement uncertainty,11 have to be examined quite carefully if their recognition will provide useful information. In the case that a recognition would not provide useful information, the items should not be recognised as assets or liabilities.
See CF (2018). chap. 4.3.
See for the major differences in comparison to the previous Conceptual Framework (2010) Kirsch/Lorentzon, Skattenytt 2016, p. 678.
See CF (2018). chap. 5.14 in combination with CF (2018). chap. 4.13 and 4.35.
See CF (2018). chap. 5.15–5.17.
See section II. 1.
3 Measurement bases
Just as the preceding ED/2015/3, the CF (2018) distinguishes two groups of measurement bases, historical cost and current value measures. Unchanged to the ED/2015/3, the historical cost and the amortised cost (especially for the valuation of some financial instruments) belong to the historical cost measures. In the opposite to the ED/2015/3, the CF (2018) supplements the circle of the current value measurement bases (according to the ED/2015/3, consisting of the fair value, the value in use for measuring assets and the fulfilment value for measuring provisions) by the current cost.12 The current cost of an asset is defined as the cost of an equivalent asset at the measurement date, comprising the consideration that would be paid at the measurement date plus the transaction costs that would be incurred at that date.13 The current cost comprise the replacement cost and the cost necessary for re-producing an equivalent asset. Just as the fair value, the current cost are derived from a market. In the case of current cost the relevant market is the market on which the entity regularly acquires the asset or incurs the liability, and insofar the current cost is an entry value.14 In deviation to the fair value, the transaction costs to acquire an asset or to incur a liability are included in the current cost.15
Beside an extensive description of the information provided by particular measurement bases in CF (2018). chap. 6.23–6.42, the focus of chapter 6 of CF (2018) is on the selection of the appropriate measurement basis. Just as the ED/2015/3, the CF (2018) avoids to match different kinds of assets or liabilities with the appropriate measurement basis. Instead of this, the CF (2018) shows the most important factors, derived from the qualitative characteristics, that have to be taken into account by selecting an appropriate measurement basis.
Like the ED/2015/3, CF (2018). chap. 6.49 deduces from the relevance the following two factors for selecting an appropriate measurement basis: the characteristics of the assets or liabilities and their manner of contribution to future cash flows. With regard to the first mentioned factor the sensitivity of the value of the asset or liability to market factors or other risks influences the selection of the appropriate measurement basis. If the value of an asset or liability is very sensitive to market factors or other risks, current value provide more relevant information than historical cost. Otherwise, historical cost can provide relevant information.16 In the opposite to the ED/2015/3, the final CF (2018) does not distinguish between different kinds of risks (market risks and risks inherent in the items)17 that cause changes in the value of the assets or liabilities. With regard to the manner how assets or liabilities contribute to future cash flows, CF (2018). chap. 6.54 distinguishes also the direct (e.g. sale of an asset) and the indirect manner (e.g. sale of goods produced by the joint use of several economic resources) of producing cash flows. CF (2018). chap. 6.56 confirms that for assets and liabilities that produce cash flows directly and their sale or disposal is quite independent from those of other items (esp. no penalties), the current value measurement bases provide most relevant information. In contrast to this, CF (2018) assesses not only the historical cost, but also the current cost as appropriate for measuring assets or liabilities that produce cash flows indirectly.18 Furthermore, CF (2018). chap. 6 emphasizes the dependence of selecting an appropriate measurement basis on the nature of the entity’s business activities.19
Unchanged to the ED/2015/3, from the faithful representation follows that assets and liabilities which are related in some way should not be measured with different measurement bases (avoidance of an “accounting mismatch”,20 e.g. measurement of provisions for damages and the therewith linked claim for compensation). Due to the classification of the measurement uncertainty as an factor influencing the faithful representation21 the measurement uncertainties linked to a specific measurement basis have also to be taken into account in the process of selecting an appropriate measurement basis.22 If a measure cannot be observed directly or otherwise be verified, e.g. by the application of a proper valuation model, it has to be checked if explanatory information is sufficient for the understandability to the users of the financial statements. In particular cases, this may not be appropriate and a different measurement basis has to be selected.23
See CF (2018). chap. 6.11 c).
See CF (2018). chap. 6.21 sent. 1.
See CF (2018). chap. 6.21 sent. 3.
See CF (2018). chap. 6.21 sent. 1 and 2.
See CF (2018). chap. 6.51 sent. 1–2.
See ED/2015/3. chap. 6.54 b).
See CF (2018). chap. 6.55 sent. 1 and in addition above in this section.
See CF (2018). chap. 6.53 sent. 2, 6.54 sent. 2 and 6.57 sent. 1.
See CF (2018). chap. 6.58 sent. 1.
Compare section II. 1.
See CF (2018). chap. 6.60.
See CF (2018). chap. 6.68 sent. 2 and 3.
4 Delineation of profit or loss and other comprehensive income
According to CF (2018). chap. 7.16 sent. 1 the statement of profit or loss (in the following p/l-statement) is the primary source of information about an entity’s financial performance for the reporting period. From this follows, that in principle, all income and expenses have to be included in the p/l-statement.24 However, the IASB may in exceptional circumstances decide that income or expenses arising from a change in the current value of an asset or a liability are to be included in the other comprehensive income when doing so would result in the p/l-statement providing more relevant information, or providing a more faithful representation of the entity’s financial performance for that period.25 These assertions correspond with those in the ED/2015/3 although CF (2018) emphasizes that all income and expenses have to be regularly recognised in the p/l-statement and permits to decide recognising particular income and expenses from changes of a current measurement basis in the other comprehensive income only in “exceptional circumstances”.
If income and expenses are included in the other comprehensive income in one period, in principle, these income and expenses are reclassified into the p/l-statement in a future period. This only applies, if by this reclassification more relevant information in the p/l-statement, or a more faithful representation of the entity’s financial information can be reached.26 However, if a clear basis for such a reclassification which provides more relevant information, or more faithful representation of the entity’s financial performance is missing, the IASB can decide that the income and expenses included in the other comprehensive income in one period is not subsequently reclassified into the p/l-statement.27 According to ED/2015/3. chap. 7.27 sent. 2 a missing clear basis for a reclassification was considered as being an indication that these income and expenses should not be included in the other comprehensive income at all. Insofar, according to ED/2015/3 a missing clear basis for reclassifying of income and expenses included in the other comprehensive income into the p/l-statement in a future period would have had an immediate effect on the inclusion of these income and expenses in the other comprehensive income in a previous period. CF (2018) does not maintain this relationship which is a significant change in comparison to the preceding ED/2015/3. Therefore, it will also still be possible in the future that particular income and expenses are recognised in the other comprehensive income that will not be reclassified.
See CF (2018). chap. 7.17 sent. 1.
See CF (2018). chap. 7.17 sent. 2.
See CF (2018). chap. 7.19 sent. 1.
See CF (2018). chap. 7.19 sent. 2.
III POTENTIAL IMPACTS OF THE CONCEPTUAL FRAMEWORK (2018)
1 Recognition of assets and liabilities
Although the CF (2018), like the ED/2015/3, confirms the waiver of separate recognition criteria nonetheless the number of assets and liabilities to be recognised in the balance sheet will not increase considerably. This could be deduced from the explanations in CF (2018). chap. 5 which point out more precisely than the ED/2015/3 the conditions under which the recognition of an asset or liability would not provide useful information and should therefore not be recognised in the balance sheet.28 Nevertheless, it could not be precluded that due to the waiver of the recognition criteria, especially the evidence of generating future economic benefits from the asset, self-generated intangibles will be recognised earlier than according to IAS 38.57 and consequently the cost of these assets will increase. Something similar applies also for the point in time of recognising provisions (i.e. earlier recognition).
Compare section II. 2.
2 Measurement of assets
a) Tangible and intangible assets
According to IAS 16.29 and IAS 38.72, IFRS applying entities can choose between the cost (i.e. cost less accumulated depreciations and impairment losses) and the revaluation method for the measurement of tangible and intangibles after their recognition.29 Due to the integration of these assets in the entity’s regular production process and the therewith linked indirect manner of contributing to future cash flows quite strong arguments included in the ED/2015/3 were in favour of using only historical cost.30
This discernible tendency of limiting the accounting choice for the valuation of tangibles and intangibles in favour of a historical cost measurement in the ED/2015/3 can not be confirmed by the assertions of the CF (2018). Instead, beside the historical cost also the current cost are assessed as being an appropriate measurement basis for those kinds of assets.31 Furthermore, CF (2018) does not any more distinguish between market risks and risks inherent in the assets. As also long-term used tangibles and intangibles are subject to disruptive technological and economical risks their fair values are subject to major fluctuations which is an argument against using a historical cost basis.32 Although the estimation of fair values of tangibles and intangibles are subject to a certain degree of measurement uncertainty, especially in the case when using a cash-flow-based measurement technique, nevertheless the current cost that also belong to the current measurement bases are mostly subject to a significant lower measurement uncertainty. Therefrom, quite some strong arguments are now in favour of maintaining the existing accounting choice for tangible and intangible assets and against an abolishment of this accounting choice which could have be deduced from the arguments included in the ED/2015/3.
See IAS 38.75 regarding the limitation of this accounting choice for intangibles without an active market.
SeeKirsch/Lorentzon, Skattenytt 2016, pp. 684–685.
See CF (2018), chap. 6.55 sent. 1 and compare in addition section II. 3.
See CF (2018). chap. 6.51 sent. 2.
b) Investment property
According to IAS 40.30, after the initial recognition the entities can choose for the investment property between the cost method33 or a measurement at fair value. Both factors derived from the relevance, the characteristics of the asset or liability and their manner of contribution to future cash flows, are in favour of using a current measurement basis.34 Regardless if investment properties are held for an immediate sale or used for generating rents, they are on the one hand regularly highly sensitive to market factors, on the other hand they produce cash flows directly.
Nonetheless, investment properties could be subject to measurement uncertainties if the prices cannot be observed directly or be derived from an active market.35 In these cases valuation models which are based as far as possible on observable input factors are used in order to estimate the fair value.36 Although the faithful representation may be restricted by a high level of measurement uncertainty envolved in using a valuation model partly based on non-observable input factors, this does not preclude the use of such an estimation. This applies especially, if the estimation is described as being an estimate and the assumptions of the estimate are disclosed.37 Furthermore, the entity can choose as an alternative to the fair value the current cost as another current measurement basis that is especially in the form of re-production cost regularly subject to a lower level of measurement uncertainty.38
From this follows that the current accounting choice of IAS 40.30 could be removed against a valuation of investment property with a current value measurement basis only. Furthermore, it has to be taken into consideration that for comparability reasons accounting choices should be avoided in general.39
See section III. 2. a).
Compare section II. 3.
See CF (2018). chap. 6.60–6.62.
See Göttsche/Cranen/Geidel/Steindl, KOR 2015, p. 593.
See CF (2018). chap. 6.68, especially sent. 1 and 2.
Similar CF (2018). chap. 6.60 sent. 5.
See CF (2018). chap. 2.29.
c) Financial assets
Except of banks and other financial institutions, in general all financial assets are not used in combination with other economic resources to produce cash flows and hence they produce cash flows directly. With regard to the variability of cash flows the value of financial assets is highly sensitive to market factors and other risks (including creditworthiness risk). In addition, measurement uncertainties for financial assets traded in an active market do not exist. Furthermore, the IASB assumes that the valuation methods for equity instruments are well-developed and insofar the measurement uncertainties are limited even for those equity instruments that do not have a quoted price in an active market.40 These arguments in favour of using a current measurement basis are valid for all financial assets, independent of the entity’s business model for managing the financial assets and the kind of cash flows generated by those assets.
As already mentioned in section II. 3, the entities’ business activities also influence the selection of an appropriate measurement basis. If financial assets are held within a business activity that envolves holding financial assets with the objective of collecting contractual cash flows (only debt instruments) amortised cost can provide useful information because this measurement basis can be a reasonable basis for the estimation of interests and has therefore a high predictive value.41 In the opposite to this, the cash flows generated from equity instruments are subject to a high volatility which serves as an additional argument for the use of a current measurement basis.
Altogether, there are strong arguments in favour of using a current measurement basis for the valuation of financial assets. This does also apply to those financial assets which satisfy the conditions for the business model for managing the financial assets according to IFRS 9. chap. 4.1.2 a) and also the characteristics of the contractual cash flows included in IFRS 9. chap. 4.1.2 b). In the case that the business model is exlusively directed on collecting contractual cash flows the high predictive value of amortised cost support only the choice of this measurement basis. Nevertheless, it has to be noticed that in most cases, no single factor will determine which measurement basis should be selected.42
See IFRS 9. BC 5.17 b).
See CF (2018). chap. 6.57 sent. 3 and in addition CF (2018). chap. 2.8.
See CF (2018). chap. 6.44.
3 Recognition of gains and losses from changes of a current value
a) Recognition of gains and losses in the p/l-statement or other comprehensive income
As already shown in section III. 2. c) current value is an appropriate measurement basis for all equity instruments. The mere existence of the current accounting choice for investments in an equity instrument which are not held for trading purposes that envolves recognising fair value changes either in the p/l-statement or in the other comprehensive income43 demonstrates that the circumstances are not as exceptional that they may justify a recognition of fair value changes in the other comprehensive income.44 Furthermore, with the sole recognition of fair value changes from equity instruments in the p/l-statement an accounting choice that disturbs the comparability could be avoided.45 However, a possible argument in favour of recognising these fair value changes in the other comprehensive income might be that in the case of a long-term investment short-term fluctuations of the fair value should not distort the p/l-statement and reduce the predictive value of its financial information.46
Similar applies also for the recognition of the remeasurements of the defined benefit liability (or asset) from pensions in the other comprehensive income according to IAS 19.120 c). From the qualitative characteristic of faithful representation it could be deduced that the defined benefit claims must be measured with a current value measurement basis. Otherwise (i.e. using a historical cost basis), the single employees’ claims (e.g. particular claim on receiving a pension payment as a certain percentage of the salary reached immediately before retirement) included in the net benefit liability (or asset) would have to be measured with different amounts in dependence of the current actuarial assumptions within the financial period in which the claims were earned. In favour of recognising these remeasurement gains and losses in the other comprehensive income is that these valuation adjustments relate to the values of pension liabilities (or assets) of preceding financial periods and not to the pension claims earned within the current financial period. Therefore, a recognition in the p/l-statement could disturb the predictive value of the net profit or loss. Nevertheless, in substance these kind of remeasurement gains and losses are adjustments of an accounting estimate. According to IAS 8.36, adjustments of accounting estimates have to be included in profit or loss. In addition, all remeasurement gains and losses of the net defined benefit liability (or asset) from other long-term employee benefits, e.g. from jubilee liabilities, are recognised in the p/l-statement.47 Therefrom, under consideration of CF (2018). chap. 7.16–7.17 a recognition of the remeasurement gains and losses of the defined benefit liability (or asset) from pensions could not be precluded at all.
See IFRS 9. chap. 5.7.5.
See CF (2018). chap. 7.16–7.18 and in addition section II. 4 of this article.
See CF (2018). chap. 2.29.
See CF (2018). chap. 7.17 sent 2.
See IAS 19.156.
b) Existence of a clear basis for the reclassification of gains and losses included in the other comprehensive income into the p/l-statement
If gains and losses are included in the other comprehensive income in one period, according to CF (2018). chap 7.19 sent. 1 it has to be checked if there is a clear basis for identifying a future financial period in which reclassification into the p/l-statement would result in more relevant information, or providing a more faithful representation of the entity’s financial performance of that future period.48 This means in detail:
In the case of the investments in equity instruments not held for trading purposes it could be argued that a reclassification of measurement gains and losses will lead to more relevant information if the cumulative gain or loss from the whole holding period of these investments is fixed (especially in the case of sale or other retirement). Moreover, the recognition of gains and losses from the sale or other retirement of these equity instruments in the p/l-statement implies a complete and free of errors depiction of the profit or loss from these equity instruments over their whole holding period. Nevertheless, it could be objected that recognising the cumulative gain or loss from holding these equity instruments could reduce the predictive value of the information contained in the p/l-statement. But a separate presentation of gains and losses from reclassifications in the p/l-statement or equivalent disclosures should avoid false conclusions.
Similar also applies with regard to a possible reclassification of cumulative gains from the revaluation of tangible and intangible assets. The reclassification can occur at the point in time of the sale or other retirement of these assets. In the case of assets that are subject to wear and tear a reclassification to the p/l-statement can take place corresponding with the depreciation from the current measurement basis over their useful lives.49 If those periods for reclassifying gains and losses from revaluation are used there would be no other effects on the p/l-statement than using the historical cost measurement. Especially the faithful representation of the entity’s financial performance (completeness and freedom from errors in the depiction of the results from these assets over their whole useful lifetimes) and a higher degree of comparability are in favour of reclassifying the revaluation gains (and losses) from tangibles and intangibles.
If the remeasurements of the net defined benefit liability (or asset) from pensions could still be included in the other comprehensive income,50 only in the particular case of a transfer of pension claims to an insurance company it is possible to identify a clear basis for reclassification. In all other cases, as the actuarial assumptions used for calculating the net defined benefit liability (or asset) are continously changing over time it is practically impossible to trace back a remeasurement gain or loss in one period to an opposite remeasurement result in a preceding period and therefore to identify a clear basis for the reclassification in accordance with CF (2018). chap. 7.19 sent. 1. Consequently, according to CF (2018). chap. 7.19 sent. 2 the recognition of an other comprehensive income which will be not reclassified to the p/l-statement at all is still possible. As already mentioned in section II. 4, this is a major difference compared to the ED/2015/3 because in the preceding ED/2015/3 a missing clear basis for an reclassification was assessed as being an indication that the income and expenses from these remeasurements should be immediately included in the p/l-statement.
See section II. 4.
See with regard to this proposal Kirsch/Lorentzon, Skattenytt 2016, pp. 686–687.
Compare the qualifying explanations in section III. 3. a).
IV SUMMARY
Major changes of the CF (2018) are the broad definition of assets and liabilities in connection with the abandonment of separate recognition criteria, the considerations of selecting an appropriate measurement basis, and the delineation of income and expenses which have to be included in the p/l-statement or in the other comprehensive income.
Although the CF (2018) cannot override any specific IFRS and the IASB emphasizes that for changing accounting rules included in an IFRS own due processes are always necessary which have also to take the particular circumstances into account, nevertheless the following tendencies for the future IFRS accounting can be identified51:
a further increase in the use of current measurement bases in the IFRS accounting (e.g. for the valuation of investment properties and financial instruments). Especially the current cost introduced in the final version of the CF (2018) can be an appropriate alternative current measurement basis if other current measurement bases are subject to a high level of measurement uncertainties.
in general, a restriction of recognising gains and losses arising from a change in the current value of an asset or liability in the other comprehensive income, especially in the other comprehensive income which will not be reclassified subsequently. Despite of this, probably there will also be in the future measurement gains and losses that will be recognised in the other comprehensive income which will not be reclassified subsequently (e.g. remeasurements of the net defined benefit liability (or asset) from pensions).
All in all, it can be noticed that the conclusions regarding the measurement of assets and liabilities and also of the delineation of the p/l-statement against the other comprehensive income in the CF (2018) are in principle derived from the objective of general purpose financial reporting and the qualitative characteristics of useful financial information and could therefrom serve as a theoretical basis for a logical deduction of new or revised standards. Nevertheless it cannot be ignored, that some explanations included in the CF (2018) are taken from some standards recently adopted, like IFRS 9. Therewith the IASB tries to justify some recent standard level decisions on a conceptual level. Nonetheless, this is quite critical as it threatens the value of the conceptual theoretical basis of the CF (2018).
Hanno Kirsch is president of Fachhochschule Westküste and professor at the Europa-Universität Flensburg, Germany.
According to CF (2018). SP 1.3, if in the future the IASB departs in an IFRS from the CF (2018) it has to explain the departure in the Basis of Conclusions accompanying that IFRS.