Accounting Standard Setters Capitulate to Financial Economics

The International Accounting Standards Board and the US Financial Accounting Standards Board have issued preliminary drafts of the first two chapters of their proposed joint Conceptual Framework for Financial Reporting. This available at the FASB web site.

The draft document appears to me to represent the triumph of financial economics over traditional accounting. For example:

• The document describes the principal objective of financial reporting as follows “To help achieve its objective, financial reporting should provide information to help present and potential investors and creditors and others to assess the amounts, timing, and uncertainty of the entity’s future cash inflows and outflows (the entity’s future cash flows). That information is essential in assessing an entity’s ability to generate net cash inflows and thus to provide returns to investors and creditors.” In its subsequent discussion of this issue, the document goes on to say “The Boards’ eventual consideration of those matters might result in a conclusion that adding a discussion of forecasts to the framework would be consistent with the focus on users’ interest in the amounts, timing, and uncertainty of an entity’s future cash flows” This is in sharp contrast to the existing framework document of the IASB which places primacy on “information about the financial position, performance and changes in financial position of an enterprise.”
• The document strengthens the importance of neutrality and completely does away with the notions of ‘conservatism’ and ‘prudence’ in a hard hitting paragraph: “Neutrality is incompatible with conservatism, which implies a bias in financial reporting information. Neutral information does not color the image it communicates to influence behavior in a particular direction. For example, automobiles might be produced with speedometers that indicate a higher speed than the automobile actually is traveling at to influence drivers to obey the speed limit. But those ‘conservative’ speedometers would be unacceptable to drivers who expect them to faithfully represent the speed of the automobile. Conservative or otherwise biased financial reporting information is equally unacceptable.”

Posted at 3:55 pm IST on Mon, 10 Jul 2006         permanent link

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