Abstract
China Journal of Accounting Studies, 2014 Vol. 2, No. 2, 77–95, http://dx.doi.org/10.1080/21697221.2014.916886 COMMENTARY What should be the nature and role of a revised Conceptual Framework for International Accounting Standards? Richard Macve* Department of Accounting, London School of Economics and Political Science, London, UK This paper asks how far we may expect the IASB’s current approach to revising its Conceptual Framework (CF) – as set out in the recent Discussion Paper on further chapters of the revised Framework – to help overcome difficulties such as those identified by Barth, M.E. (2013). Global Comparability in Financial Reporting: What, Why, How, and When? China Journal of Accounting Studies, 1:1,2–12. She identifies the importance – given the IASB’s aim in its CF to achieve international comparability in financial statements – of developing improved ‘high quality’ standards for recognition and measurement. I argue that the unavoidable conceptual and institutional difficulties inherent in comparing economic ‘realities’ require that the revision of the Framework should be more fundamental than attempting to improve the recognition and measurement elements of the prevailing ‘balance-sheet’ focused model. Rather than continuing to seek universally applicable answers to provide ‘a complete and updated set of concepts to use when it develops or revises IFRS’, it should instead focus on highlighting the key questions that IASB needs to consider when setting standards. I comment on possible implications for the future development of accounting internationally, and on future research opportunities, with particular reference to China. Keywords: comparability; global financial reporting; International Financial Report- ing Standards; Conceptual Framework; China 1. Introduction When I took my final ICAEW Chartered Accountancy examinations in November 1971, the UK had only one accounting standard in force. The determination of the numbers in published UK accounts, for more than 100 years or so before had been left to (almost entirely secret) professional judgements of what was ‘a true and fair view’, later strengthened by some Company Law provisions and by ‘recommendations’ from ICAEW. About ten years later, I submitted my report to the UK standard setter advis- ing that it would not be worthwhile to try to develop a ‘conceptual framework’ (CF) comparable to the FASB’s, given the inherent limitations of what such an official framework could achieve (Macve, 1981). Nowadays accounting standards, originating in the US in the 1930s, have become international and (alongside international auditing standards) are regarded as an integral part of the architecture of the global financial system. Many voices besides IASB now claim rights over them and influence their direction in a contested ‘regulatory space’ (e.g. Freeman & Rossi, 2012; Macve, 2014a; cf. Waymire & Basu, 2007). Academic *Email: R.Macve@lse.ac.uk Paper accepted by Jason Xiao. © 2014 Accounting Society of China 78 Macve accounting has correspondingly mushroomed and its research agendas have become increasingly dominated, at least in the US and increasingly elsewhere, by capital- markets based empirical research into the relationships between accounting numbers and the behaviour of share prices, complemented by developments in formal analytical modelling. Should I now change my mind about the prospects for a CF given that the IASB’s revived project responds to the recent result from the survey of its constituents that completing the CF (which had been ‘on hold’) is a priority (IASB, 2013a, b)? Barth (2013) sets out the case for the importance within its CF of IASB’s aim to achieve international comparability in financial statements through developing ‘high quality’ standards. But as Zeff (2007b, p. 294) argues (after reviewing several basic recognition and measurement problems similar to those that she reviews): The question is whether the same method to be used by all companies around the world produces ‘genuine’ comparability or ‘superficial’ comparability. This is a debate that has not been adequately taken up in our literature. Referring to the simplistic desideratum that ‘like things should look alike, and unlike things should look different’ does not address the essence of the conundrum of accounting comparability and how it is to be achieved. 2. Uniformity or comparability? Why the conundrum? Barth (2013) distinguishes, for example, a universal rule of depreciating property, plant and equipment over a 10-year life from one that allows each company to use the life that it thinks is appropriate for the asset in question. She argues that the former can achieve uniformity (which appears to be closer to Zeff’s ‘superficial’ comparability), but questions how the resulting amounts can be compara- ble when the actual assets’ lives vary so much? The latter rule therefore offers the hope of more genuine comparability. But now we have to note that different firms using otherwise identical assets in otherwise identical circumstances could legitimately differ in their estimates of uncertain useful lives and so the resulting numbers may still not be truly comparable, but remain only superficially so. Presumably, however, if given enough detail about the managements’ assumptions, and perhaps some sensitivity anal- ysis, users might be able to work out what the numbers would be if they substituted their own assumptions in each case, thereby gaining more ‘genuine’ comparability. But these alternative computations must generally be part of users’ financial analysis rather than achieved within the financial statements themselves. Similarly, while requiring inventory to be stated at ‘lower of cost and net realizable value’ favours greater comparability over the uniformity of always requiring, say, cost, the IFRS standard (IAS2) in forbidding LIFO (which US standards still allow as the measure of cost) imposes a uniformity given that some firms might argue that LIFO better reflects their actual inventory flow (Zeff, 2007b, e.g. where a base level has to be held for operational needs). Similarly, forbidding ‘pooling of interests’/‘merger’ accounting and requiring ‘purchase’/’acquisition’ accounting for business combinations imposes uniformity on situations that may include genuine mergers – and more seri- ously may even discourage advantageous combinations through requiring one company and its management to be designated as having ‘taken over’ the other. Given these limitations, why does the evidence suggest that IFRS are highly valued (e.g. Horton, Serafeim, & Serafeim, 2013)? What may be most important for investor confidence is the ‘network effects’ (e.g. Liebowitz & Margolis, n.d.) of knowing that there is common basis from which companies may be compared given that they report within the same legitimate regime of common standards. Investors (and others) know China Journal of Accounting Studies 79 that IFRS are developed through adequate due process, are supported by audit and reg- ulatory enforcement, and operate in corporate governance environments that provide appropriate management incentives (cf. Ball, Robin, & Wu, 2003; Chen & Zhang, 2010) and where other international institutions (e.g. the IMF, the World Bank and the Financial Stability Board) increasingly expect compliance from the initiatives they will support. Stock-market regulators may also want the comfort (or defence) of being able to show there are authoritative accounting rules in place, more than the markets them- selves – insofar as they are ‘efficient’ in processing information from multiple sources – actually need them. The technical information quality of the individual standards may therefore be of lesser concern (e.g. Edwards, 1938; cf. Levinson, 2006; Meeks & Swann, 2009). Such ‘network effects’ of the increasing mandatory worldwide adoption of IFRS (together with the increased knowledge about and focus on accounting reports emphasised as a result) make the value of such a coordination system hard for econom- ics to analyse; so gauging what would be an individual improvement within the system requires consideration of not only technical, economic and perhaps environmental efficiency but also political judgements as to where benefits and costs should fall. So in investigating whether systemic effects of standards (such as improved ‘com- parability’) may be more significant than their individual quality, we need to dig a bit deeper. We must ask whether the empirical evidence that investors value IFRS, and reward firms that join this system (e.g. through reduced cost of capital and/or through reduced bid-ask spreads), reflects the attractiveness of comparability (as argued by Barth, 2013, among others) or the fact that, in practice, IFRS have so far mainly made treatments more uniform and therefore more easily understandable (i.e. financial state- ments are expressed in ‘a common language’). While early steps towards uniformity will probably also increase comparability (e.g. not allowing the immediate writing off of all property, plant and equipment brings some increase in both, even if the deprecia- tion rule is uniform), the danger is that as uniformity is further increased there comes a tipping point where ‘genuine’ comparability begins to be compromised (as in the examples given above). So, while the studies by Armstrong, Barth, Jagolinzer, and Riedl (2010) and Barth, Landsman, Lang, and Williams (2012) (discussed in Barth, 2013) as well as by Brochet, Jagolinzer, and Riedl (2014) indicate that the most valuable feature is that IFRS does make different countries’ accounts much closer in how they present financial information, it is not clear that the relative contribution of greater uniformity can, at the level of progress so far made in standards, be distinguished from that of greater ‘genuine’ comparability. Given the severe limits to the comparability achievable in standards that are set out by Barth (2013), it may be that it is the uniformity that the IFRS have been more successful in achieving so far that is the more powerful factor driving the current advantages of their adoption. To this extent, one might think that almost any standards might do in achieving the basic uniformity that brings basic comparability. But stock-market prices and efficient capital allocation in the economy will also depend on how good the managerial decisions and actions are within firms (e.g. Coase, 1990). Individual standards can here make an important contribution even when arguments over the ‘best’ accounting treatments remain controversial. For example, FASB/IASB standards on pensions and other post-retirement benefits, on leases, and on executive stock compensation [‘ESOs’] have arguably raised managements’ awareness of very significant costs that they had previously overlooked or preferred to ignore. Implementing some standard in these areas has probably been more important than getting agreement on the ‘right’ standard: ‘the best should not be the 80 Macve enemy of the good’. However, if operational managers’ decisions and incentives are adversely influenced by ‘bad’ management accounting practices that have been dictated by top-level managers’ concerns about perceived potential stock-market impacts of finan- cial accounting and financial reporting outcomes, then there can be real damage even if the stock-market itself is in fact ‘informationally efficient’ enough not to be ‘fooled’ by such practices (Coase, 1990; cf. Beaver, 1998; Christensen, 2010; Graham, Harvey, & Rajgopal, 2005). So IASB also strives to achieve the ‘best’ (‘high quality’) standards that it can and the CF is seen by many as providing the basis needed to develop these in a consistent, principled way – aiming for a higher level of genuine comparability – and thereby reduce much of the controversy over the merits of individual standards. There is indeed an important role for ‘good accounting’. 3. What are the prospects for a revised CF? As noted above, IASB’s consultees regard completion of the CF as a priority. IASB’s objective for the project is to provide ‘a complete and updated set of concepts to use when it develops or revises IFRS’ (IASB 2013b, p. 1).This ‘second attempt’ at a CF is perhaps what Samuel Johnson might have labelled a ‘triumph of hope over experi- ence’, given that the FASB started developing its CF in the 1970s and it has not yet approached completion (Macve, 1997; Zeff, 1999). Nevertheless, let us initially accept as a starting point the IASB’s stated objective of financial reporting ‘to provide finan- cial information … that is useful to users of financial statements (existing and potential investors, lenders and other creditors) in making decisions about providing resources to the entity’– as this objective is not now being reconsidered in the revision project (IASB, 2013a, 1.35(a)). However we must also note that stating an objective for IFRS is not the same as recognising all the purposes that people may actually use accounting, and in particular financial accounting and financial reporting, for. Given the objective, the first problem is that – although the IASB (in IAS1) refers to the primary financial statements as providing information about financial position and financial performance – the ‘statement of financial position’ is still what for many centuries was more honestly labelled simply as a ‘balance sheet’. It is just the output from the double-entry bookkeeping system (DEB) of the open ‘ledger balances’ (Edwards, 1938) prepared according to a variety of ‘accounting principles’, of which there is potentially an almost infinite number of combinations, albeit now limited to some extent by the rules in accounting standards and by other conventions. Under IASB’s approach, changes in balance sheet net assets (apart from transactions with owners) drive the measurement of profit and loss [‘P&L’]/earnings, except insofar as some gains and losses are reported as ‘other comprehensive income’ (which I discuss further below). Note in particular that DEB itself prescribes nothing about what these ‘accounting principles’ should be: it does not constrain what assets and liabilities, or income and expense items are to be recognised; and they may be measured according to a variety of approaches (as historically they generally have been – e.g. Yamey, 1977). A balance sheet total may therefore be more analogous to the ‘hash totals’ used in modern computer systems to check completeness and accuracy of processing rather than to a representation of ‘financial position’, although individual elements of it may be more or less informative in various circumstances through the lens of ‘financial analysis’ (e.g. Penman, 2011). China Journal of Accounting Studies 81 Three major conceptual issues immediately arise: first, and the most serious, that – despite what the IASB (2013a) Discussion Paper appears to claim at 1.35(b) and (c) – only under highly idealised conditions could amounts reported for net assets and net income through the DEB system represent the economic magnitudes that inves- tors are interested in comparing when assessing alternative investment opportunities (e.g. Bromwich et al., 2010; Edwards, 1938); second, that in fact the statements do not include all economic assets and liabilities, but only those that the accounting standards’ rules ‘recognise’; and third, that these are measured on a variety of bases. It will there- fore only be by coincidence that a change in the amount of the reported net assets dur- ing a year captures the change in the overall financial position of the business entity for that year, although it may, to a greater or lesser degree, assist users in estimating that financial position and what some important aspects of its failure or success may have been. Barth (2013) and Zeff (2007b) focus on how the second and third problems cur- rently limit the comparability that can be achieved through financial statements and these have long been debated (e.g. Macve, 1997). Is it likely they will be overcome? On definition and recognition, IASB (2013a, b) proposes to tinker with the defini- tions of assets and liabilities (although the attempts at slightly different definitions in different frameworks at different times do not seem to have made any practical differ- ence – see Macve, 1997) but has little to say about recognition beyond updating the current CF criteria to reflect other changes in IASB terminology and add the comple- mentary criteria for ‘derecognition’. The reworded criteria appear to put greater empha- sis on IASB having to give reasons to justify not recognising, say, internally developed intangibles (e.g. research or a better-trained workforce or internal goodwill) or execu- tory contracts or contingent liabilities for legal penalties and damages. However, again it is not clear that this shift in emphasis would in itself be likely to change the outcome of any review of an existing standard. Refining the CF in this way will not in itself shift financial statements to being more ‘comprehensive’ and thereby more comparable. On measurement, IASB (2013b, p. 6) is proposing that alternative bases may con- tinue to be used (as in the present ‘mixed model’), although the number of alternatives should be limited as far as possible, and ‘in selecting an appropriate measurement basis for a particular asset or liability, the IASB should consider: (a) how the asset contributes to future cash flows or how the entity will fulfilor settle the liability; and (b) what information that measurement basis will produce in the statement of financial position and the statement of comprehensive income.’ This approach does not favour any particular basis, although it should be noted that for accounts required to be prepared under US GAAP the SEC has traditionally insisted as far as possible on using historical cost [‘HC’] (Zeff, 2007a), which means that there is little tradition in the US outside academe of analysing issues relating to valuation of assets and liabilities that are not ‘financial instruments’. Longstanding examples from the US of arguments emphasising that comparability requires measures of current values include MacNeal (see, for example, Zeff, 1982) and Edwards and Bell (1961), while from Australia they include Chambers (1966) and from the UK Baxter (1984) (with income also needing to be adjusted for changes in purchasing power under inflation). If it were possible to adopt a single measurement basis this would help to eliminate ‘accounting arbitrage’ (i.e. where assets and liabilities 82 Macve are classified so as to be able to use what managements see as the most favourable accounting treatment) – but IASB has had to retreat from its earlier ideal of using FV as widely as possible. IASB continues however to give only cursory, dismissive analysis to the valuation method that was previously supported by the UK’s Accounting Standards Board and that most rigorously analyses how an asset will relevantly ‘con- tribute to future cash flows…’ – generally known as ‘deprival value’ [‘DV’] – which has received extensive discussion in the academic literature as well as in UK and Australian government-backed policy arenas (IASB, 2013a, 6.42–6.43; cf. Lennard, 2010; Macve, 2010b; Weetman, 2007: Appendix). While it inevitably shares some of the same limitations as other ‘current value’ methods it should therefore be treated seriously as a candidate for the answer to the question raised by Barth (2013,p.5): Perhaps another measure exists that overcomes the undesirable features of both modified historical cost and fair value and possesses desirable features. Unfortunately, standard setters have yet to identify such an alternative measure. Because deprival value focuses on choosing the measure that most relevantly reflects the available business opportunities, it also fits with the idea that ‘business model’ type arguments may be relevant in determining, if not balance sheet values, at least different components of income (IASB, 2013a, 9.33; cf. Barth, 2013, pp.7–8; Horton & Macve, 1996; ICAEW, 2010). It seems unlikely therefore that this revision of the CF will do much to assist standard setters in enhancing comparability along the dimensions of recognition and measurement. But the first major conceptual limitation raised above is even more significant. Economic decisions are about the future: accounting information is primar- ily about the past, albeit modified through ‘conditional conservatism’ (Basu, 1997)to ensure that (at least some) liabilities are accrued for and recognised assets are not stated above ‘recoverable cost’ (Solomons, 1961). So there is inevitably some estimation of the ‘future’ in financial statements even though they are often assumed to be about ‘the past’ (Barth, 2006; Edey, 1970) and increasingly it is areas where the future dominates the measurement (e.g. impairment of goodwill and other intangible assets; provisions for bank loan losses; provisions for liabilities such as insurance claims and ongoing insurance obligations, or for legal damages, or for pensions and other post-retirement benefits, or for environmental and other constructive liabilities) that produce both some of the biggest numbers in the accounts and the major problems for standard setters. This need for estimates inevitably requires differing degrees of subjective judgement, which clearly cannot be wholly standardised. So one literally cannot know if Insurance Company A’s provisions actually are comparable to Insurance Company B’s for the same events. Moreover, in defining the rules for application of these measurements, standards have to face the ‘cross-cutting’ issue of the problem of ‘the unit of account’ (the level to which contract assets and liabilities may be aggregated in determining, for example, what overall provisions are required and/or risks may be offset). This was recognised as a major problem at the beginning of the then joint FASB/IASB attempt to revisit the CF (FASB/IASB, 2005), where it was hoped that one outcome of the revision project would be to make progress on such ‘cross-cutting issues’ at a conceptual level that would help bring consistency across a range of standards. But in its Discussion Paper (2013a, 9.38) IASB now states: China Journal of Accounting Studies 83 The IASB’s preliminary view is that deciding which unit of account will provide the most useful information to existing and potential investors, lenders and other creditors will nor- mally be a decision for projects to develop or revise particular Standards, rather than a decision that can be resolved conceptually for a broad range of Standards. It then just refers to the broad qualitative characteristics, and the need for benefits to exceed costs, as the kinds of general issues to be considered at that stage. Meanwhile, the decisions in individual standards often appear arbitrary and unlikely to reflect the way in which the stock-market would perceive and price the related risks on a portfolio basis (e.g. currently in the IASB’s proposals for insurance contracts). And even while they include these increasingly important future oriented measure- ments, the underlying basis of preparation of accounts remains past transactions and existing contracts, which cannot in themselves capture most of the information about the future that investors need to use and is impounded in stock-market prices (e.g. Jiang & Penman, 2013; Penman, 2011). 4. The problem of ‘OCI’ It is widely recognised that a major ‘hole’ in the CF that has become glaringly apparent in recent years has been the lack of a theoretical basis for deciding what ‘recognised gains and losses’ should appear in P&L/earnings and what should be classified as ‘other comprehensive income’ [‘OCI’], together with the related issue of how far items reported in OCI should later be ‘recycled’ into P&L/earnings, e.g. when revaluation gains are ‘realised’. The underlying theoretical problem here is that there can be no single concept of ‘what is income?’ and therefore of how it should be subdivided and displayed. As Hicks argued (Bromwich et al., 2010) income measured as ‘change in the value of wealth’ (his ‘No.1’ version), may not be the same as income measured as ‘maintainable income’ (his ‘No.2’ version). The former is formally closer to accounting’s ‘asset and liability’/‘balance sheet’ approach to measuring income; the latter is perhaps formally more similar to what the ‘matching revenue and cost’ approach, and in particular the presentation of ‘core earnings’ (see below), often aims to achieve. Changes in interest rates cause significant difficulties here and price changes add further complexity. Standard setters have felt constrained by the articulation provided by DEB to treat all changes in net assets (apart from transactions with owners) as income of a kind (the ‘clean surplus’ approach), but without much conceptual consistency in determining what kind. So IASB has been unable to define what net profit/earnings should comprise and has been left with identifying a variety of items that should be excluded from it and presented as OCI. Here, the IASB’s current proposals do indicate the beginnings of a new and potentially more helpful approach. Current OCI items are a mixed bag (including some very large items such as actu- arial variations in pensions and the effect of credit rating changes on own debt) and the latest proposals on hedge accounting are adding more. The IASB now proposes that OCI items should only include those resulting from certain remeasurements of assets and liabilities, some of which should subsequently be recycled into P&L. It helpfully distinguishes different possible categories of these remeasurements (IASB, 2013b, p. 9), although many conceptual difficulties remain in determining an adequate basis for distinguishing which of these should and should not go into P&L and whether and when they should subsequently be recycled. 84 Macve For example, if revaluations of assets above historical cost are deferred from entering P&L until ‘realised’, not only is a workable definition of ‘realised’ needed (cf. Carsberg & Noke, 1989) but it leaves open the possibility of manipulation of earnings by the selective timing of asset realisations (and correspondingly of liability settlements – e.g. Macve, 1984). Moreover, deciding whether revaluations should be immediately recognised in P&L or deferred through OCI requires defining the benchmark by which profit is to be measured – the appropriate ‘capital maintenance concept’– as well as what ‘critical event’ in the progress of a contract is to be regarded as providing sufficient certainty of realisation for a profit to be recognised. Could there even be recognition of profit on inception of a contract (‘Day 1’) – or even before (cf. Wagenhofer, 2014)? Even for financial instruments the interpretation of value changes and how revaluations should be reported can be problematic (Horton & Macve, 1996, 2000). It was recognised at the beginning of the then joint FASB/IASB attempt to revisit the CF that IASB and FASB differed over what capital maintenance concepts – e.g. ‘physical’ or ‘financial’– might be accepted (FASB/IASB 2005, p.10). However, in its current Discussion Paper (IASB, 2013a, 9.45.–9.54) IASB now sidesteps the issue by regarding it a problem that is ‘probably most relevant’ only under high inflation. But it is by definition the necessary complement to any decision on what is or is not to be recognised as ‘income’ (e.g. Baxter, 1984) and is therefore essential for any concep- tual progress on the major issues about OCI and recycling. The CF revision project must address it now. The Discussion Paper could have usefully taken one step forward by raising the more immediate question of whether some of the items currently presented in OCI are indeed ‘income’ of any kind at all at the stage that they are currently recognised. For example, mismatches resulting from just one side of a hedge being remeasured are really just being ‘parked’ until the items can be fully matched and the overall results meaningfully included in profit and loss. The OCI is here basically just a ‘suspense’ account so it is surely misleading to call these items ‘other comprehensive income’ alongside others that more clearly are. Using a ‘suspense account’ would be a break with the ‘clean surplus’ approach that IASB has so far taken and would require admit- ting more balance sheet elements than just ‘assets’, ‘liabilities’, and ‘equity’ but – given that accounts cannot themselves measure the value of a business and therefore that they can never fully measure its ‘comprehensive income’ (Bromwich et al., 2010) – label- ling such items as ‘suspense account’ items would be a more straightforward and ‘plain-speaking’ approach than continuing to include them in OCI. And provided all elements are clearly displayed and explained users would remain free to reclassify them for their own purposes. 5. ‘Core earnings’ The exclusion of certain items from P&L also raises questions about the publication alongside IFRS earnings of what in the UK are known as ‘core earnings’, which both preparers and analysts often appear to find more useful than the IFRS numbers in trying to convey ‘genuine’ comparability of results. While there are dangers of opportunistic reporting (e.g. Zeff, 2007b) these appear to be outweighed overall by the advantages of getting a closer insight into management’s own interpretation of the business’s (and their) performance. Enforcement disciplines such as requiring full reconciliation to the IFRS net income and audit scrutiny mitigate the dangers (e.g. Young, 2014). But the China Journal of Accounting Studies 85 practice raises the key question of why are the adjustments commonly made to arrive at core earnings not already incorporated into the reported IFRS measure? This brings out an underlying ambiguity at the heart of the IASB agenda: should standards reflect what investors and others find useful (as the CF’s objective might be taken to imply) or what the ‘experts’ (the standard setters) believe to be ‘the best accounting’ for net asset and profit measurement (Zeff, 2013; cf. Dennis, 2014, p.113)? The initial mandate from the SEC to the US accounting profession in the 1930s to ‘narrow the differences in accounting treatment’ has continued to drive US and now international standard setting and this focus on finding the ‘right’ measure of profit and net assets has culminated in the FASB’s and now the IASB’s search for a comprehen- sive CF (Macve, 1997; Zeff, 1999). And this is apparently what their constituents still demand (IASB, 2013a, b). It is therefore relevant now to ask whether recent significant changes, such as the freedom to develop IFRS without the constraint of necessarily converging with FASB, and the change of IASB chairman, have now shifted the IASB’s emphasis more from this second motivation towards the first. If so, the issue of who legitimately decides what is ‘useful’ (rather than ‘what is good accounting’) will become more pointed, especially as IASB’s scope extends to more and more countries with different business and financial cultures, differing roles for accounting and auditing, and different regula- tory systems and cultures, such as China (cf. ICAEW, 2012). 6. IASB in a globalised world and its relevance to China The perceived need for a CF is inversely related to the standard setter’s perceived legitimacy and positively related to perceived challenges from other competitors in the regulatory space (Macve, 1983). In the past, national standard setters have had, to a greater or lesser extent, the political backing of state agencies and IASB similarly has gained support from the political institutions of the countries that have adopted IFRS, albeit sometimes with caveats. But the wider the IASB’s global reach, and perhaps particularly now that the previous strong link of co-operation with the FASB (itself under the oversight of the SEC) has weakened (cf. Barth, 2013), the more IASB finds itself ‘floating free’ and having to develop ‘accounting without a State’ (Power, 2009) so that the CF becomes more significant as a badge of its legitimacy. As Allen & Ramanna (2013) point out in the US context, the influences on standard setting necessarily include the background education and experience of the standard setters themselves and thereby their own CFs (Zeff, 2013) so that in an international setting it will increasingly become harder to find common conceptual ground. In China, the approach so far has been to incorporate IFRS as Chinese Accounting Standards where they are seen as appropriate – and in fact very few exceptions now remain. This is considered to have increased the informativeness of reported earnings in the Chinese equity market (Lee et al., 2013). The political will for ‘continuous and full convergence’ in due course is clear and China has already been able to influence IASB (which has one Chinese board member) through the change to IAS 24 on related party disclosures to reflect the particular economic prevalence in China of its ‘State Owned Enterprises’ [‘SOE’] and thereby enable Chinese companies to comply (cf. Jiang & Penman, 2013). 86 Macve Barth (2013) insists that: it is important for all entities to apply all standards that are word for word the same around the world – not ‘almost the same as’, ‘similar to’,or ‘based on’ IFRS. Until all entities apply exactly the same standards, the necessary first step in achieving comparability will not have been taken. But is this necessary? Especially when it must be recognised that much can be ‘lost in translation’ not only at the surface level of the words of the standards but more fundamentally in how they are interpreted and implemented in different countries and environments. The nature of ‘translation’ of international accounting and auditing standards of Western origin into the very different cultural context of today’s ‘socialist market econ- omy with Chinese characteristics’ (where for example relationships – guānxì [关系] – are so important (e.g. Upson, n.d) and where bank finance is still more important than stock-market finance (e.g. Fan & Morck, 2012)), is bound – as Mennicken (e.g. 2008) has demonstrated in the case of Russia – to involve its own unique ‘re-interpretations’. Hoskin, Ma, and Macve (2014) point out that Chinese history had not previously followed any similar trajectory to that in which very significant stages of accounting’s development in the West had been engendered. This creates a very exciting environ- ment for future research into understanding international ‘translation’ into one of the world’s oldest civilisations, at the beginning of the twenty-first century, of practices and discourses that have arguably only fully gained their power in the West within the last 100 years or so. As with other kinds of ‘international Codes’– e.g. the Global Report- ing Initiative [‘GRI’] or the Equator Principles [‘EP’] (Macve & Chen, 2010) – pro- gress is likely to be heavily conditioned by the particular ‘constellation’ of the social, economic, political, legal and other forces that are already there and may continue to modify the meaning and implementation of both international accounting and interna- tional auditing standards in reflecting ‘Chinese characteristics’. But these forces are themselves rapidly changing and developing and may also be further changed in unforeseen ways by this new interaction. What is important is assisting investors and other users to understand where the important differences lie. Understanding of the significant factors and their various his- torical pathways in the Chinese context is key to understanding the trajectory that the development of the accounting and auditing profession and institutions in China may take over the next decade and beyond, and its potential impact internationally (Deng & Macve, 2013). It is therefore also key to understanding the significance of the account- ing results reported by Chinese companies, and how that may be changing, and there- fore how they may properly be compared with those of other countries (for all of whom a similar range of factors applies in differing degrees). Research that considers not only economic but also political and social factors, and looks not just at the num- bers but at the institutional and organisational context in which they are produced, is very important and, with respect to China, there is considerable scope for collaboration between Western and Chinese researchers in developing mutual understanding (e.g. Deng & Macve, 2013; Hoskin et al., 2014; Yuan, Ma, & Macve, 2014). 7. Concluding remarks Based on his recent experience as a UK Chartered Accountant in Beijing, Upson (n.d.) concludes: China Journal of Accounting Studies 87 Now that Chinese companies have a more direct interest in what IFRS say, I hope they will speak out when those standards make assumptions that do not hold in China or when IFRS fail to reflect the full sophistication of Chinese business practices. That way, IFRS will be improved not only for the benefit of Chinese preparers and users of financial state- ments but for other preparers and users worldwide. The detailed rules in standards themselves (provided they are implemented and enforced) can at most guarantee reasonable uniformity of treatment and, as Barth (2013) argues, this does not necessarily achieve (and may prevent) true comparability that reveals what is alike and what is not in different firms’ financial position and per- formance. The latter requires inevitably subjective estimates about liabilities and judge- ments about values (even if limited to ‘recoverable amounts’ based on HC rather than FVs or DVs). The attempts to improve the recognition and measurement elements of the current IASB CF cannot overcome these and other problems (including the funda- mental issues about what is income and the related questions about capital maintenance concepts and the role of OCI) in reflecting the differing contexts in which financial accounting results are stated (Zeff, 2007b). A different kind of CF is needed, one that is more realistic about what can be achieved and that starts with an initial critical understanding of the usefulness of exist- ing accounting conventions in their differing contexts and then focusses on identifying the key questions that IASB must ask when considering a new standard, including why it would be better than the existing conventions (Bromwich et al., 2010; Macve, 1981; cf. Jiang & Penman, 2013, section 5). As new standards are developed, this process of reflection, leading to possible further changes in design, must be continuously, recur- sively repeated (e.g. Dennis, 2008, 2014). The aim must be to go beyond the original achievement of Paton and Littleton in 1940 in cementing and largely justifying the basis of existing ‘historical cost’ accounting practice (Zeff, 1999) to continuous critical evaluation of where, when and how far, change is needed. In this respect, completing the current Discussion Paper (IASB, 2013a), and raising the issues the Board needs to address when considering a new standard or changing an existing one, is perhaps as much as can realistically be expected. Here, concepts can help to structure discussion – but in accounting there are conceptual ambiguities that have long been recognised as irresolvable. Accounting practice comprises conventions that have evolved at different times and places for different reasons. The most promis- ing approach therefore is not to look for concepts that can replace conventions (as FASB/IASB, 2005 proposed) but to understand the reasons for existing conventions and then critically evaluate – by reference to both concepts and consequences – whether they are still useful for the objectives of financial reporting (Bromwich et al., 2010). And as the IASB’s scope extends to more and more countries with different business and financial cultures, differing roles for accounting and auditing, and different regulatory systems and cultures (Zeff, 2007b) it is unavoidable that the attempt to achieve uniformity may in itself reduce genuine comparability (cf. Barth, 2013). So fur- ther compensating disclosures are needed to help users understand the important con- textual factors within which the accounting numbers have been produced. While the mantra of standard setters has been that ‘good disclosure is not a substitute for good accounting’ the reverse is equally true: ‘good accounting is not a substitute for good disclosure’. They are complementary. But the IASB must satisfy its constituents: and what the world, including now China, seems to need to believe – if there is to be freely globalised investment – is that 88 Macve (apparently) comparable financial statements will enable them to meaningfully evaluate investment choices in a variety of companies around the world of which they have no direct knowledge: companies with very different characteristics, operating in very dif- ferent economic, political and social environments. Presumably that is why they still think the CF in its familiar form can and must, now be finalised. If globalised invest- ment is to be sustained, investors, investment intermediaries and regulators need to believe and act as if financial statements can provide meaningful, comparable informa- tion that can be evaluated for them to take ‘action at a distance’. This is a necessary ‘rational institutionalised myth’ that sustains the power of accounting and auditing in the modern world (Power, 1997; Macve, in press). A ‘bottom line’ number is needed, not just for contractual and tax ‘settling up’ purposes, but for use as a (apparently) meaningful statistic in a variety of arenas. So a wider sociological understanding (e.g. Miller, 2008) of how accounting shares its role with other calculative techniques and measures (similarly based in ‘rational institutional myths’) is now essential when considering how to construct and utilise meaningful standardised accounting ‘performance index numbers’ (e.g. ‘return on investment’ [‘ROI’]). Such accounting metrics operate within a world of many increas- ingly powerful indices that, individually and collectively, give governments and other agencies, as well as business firms, the (illusion of?) control at a distance, at the same time as providing the ‘proxies’ needed for statistically-based empirical academic research in all social science disciplines. But the more accounting is made uniform the greater the need to understand the underlying differences between countries and firms. The IFRS standardised account- ing measures need complementing, for example by ‘core earnings’ and also relevant disclosures that help users to understand the context within which the IFRS number is being produced (Edwards, 1938). These varied contexts will increasingly need due con- sideration in debates that have until now been in arenas largely dominated by the influ- ence of the US and then the EU. The CF therefore needs to address and make transparent the policy for how the IASB should accommodate different accounting tra- ditions (which may themselves be rapidly changing) in promulgating standards that will be globally acceptable and how it should assist investors (and others) in understanding how accounting results from these differing contexts around the world may properly be compared. China here has an important role to play in showing that Western preconceptions of what are ‘like’ and ‘unlike’ things may need adaptation to fit the new era where China is widely predicted to be on track to become the world’s largest economy and is already a major overseas investor. And as others have also argued (e.g. Sunder, 2008), China’s accounting research should correspondingly have wider horizons that comple- ment cutting-edge Western-style stock-market impact and analytical studies with explor- ing (wherever possible collaboratively) the factors that investors and others need to understand about China. Above all, research should aid understanding of how the Chinese context and its institutions, within which the accounting numbers are produced and used, have been shaped historically, how they operate today, and how they are changing. Acknowledgements This paper is based in part on panel-session presentations made at the AAA annual meeting in Washington, DC in August 2012 (now published as Macve, 2014a) and at the UK FRC’s China Journal of Accounting Studies 89 Accounting Academic Panel in London in March 2014. I am grateful to my panel colleagues (particularly Professor Stephen Zeff) and to the other participants at these events for their comments, as well as to the CJAS reviewers and editor for their helpful suggestions. Notes 1. The early UK Companies Acts had used a variety of terms (such as ‘full and fair’, ‘true and correct’) until the 1947 Companies Act finally settled on today’s ‘true and fair’ (Edwards, 1986). 2. SSAP 2 Disclosure of Accounting Policies came into effect for accounting periods starting on or after 1 January 1972. For the UK’s previous Recommendations see Zeff (2009). 3. I supported developing both of these research approaches (alongside others) in Macve (1981, ch.10). See also Ashton et al. (2009). 4. Their demand for improving the CF may reflect constituents’ bewilderment over the IASB’s changes from its initially proposed FV measurements for revenue recognition and insurance back to more traditionally conservative profit recognition approaches. Penman (2013) reflects the state of the joint FASB/IASB CF discussions before the IASB’s new initiative. My comment letter of 12 January 2014 to IASB on its July 2013 Discussion Paper can be found at: http://www.lse.ac.uk/accounting/facultyAndStaff/profiles/macve.aspx. 5. Some sensitivity analyses are now reported within financial statements, e.g. for various risks under IFRS7 and IFRS9, see http://www.iasplus.com/en/standards/ifrs/ifrs7 (accessed 1 April 2014). However, in a recent review of disclosure practice ICAEW (2013) quotes various users and commentators who believe that much of the apparent comparability now man- dated in financial statements actually disguises the real differences between different compa- nies at different times and in different situations. 6. For example, it was claimed by their managements that the 1999 merger of Astra and Zeneca into AstraZeneca could not have proceeded if it could not have been presented as a ‘merger of equals’, cf.: http://www.astrazeneca.com/Media/Press-releases/Article/19,981,209– ASTRA-AND-ZENECA-IN-MERGER-OF-EQUALS-TO-CREATE-A-GLOB (accessed 8 January 2014). So ‘merger accounting’, which was still then allowed under UK GAAP, was used to avoid branding it as a ‘take-over’. 7. See for example http://www.imf.org/external/np/exr/facts/sc.htm ; http://www.worldbank.org/ ifa/rosc_aa.html ; http://www.financialstabilityboard.org/cos/cos_021001a.htm (all accessed 26 January 2014). 8. See for example http://www.ifrs.org/Alerts/PressRelease/Pages/IOSCO-and-IFRS-Foundation- agree-joint-protocols-September-2013.aspx (accessed 9 January 2014). 9. Compare for example a traffic light system. The confidence that road-users (especially from other countries) gain from knowing that uniform rules (like ‘stop on red’) will be obeyed may far outweigh the differential merits of different rules in different countries (e.g. ‘always stop on red’ versus ‘you may turn on red when the adjacent lane is clear of vehicles and pedestrians’), and even if it might be regarded as occasionally economically optimal to break the rules (e.g. why does it remain illegal to go through a red light on a clear country road when it can be seen there are no other vehicles, pedestrians or animals in the vicin- ity?). And while a town-centre traffic regime of ‘no signals’ may also be effective (Waymire & Basu, 2007, p. 79, fn.59) it is presumably vital to inform drivers from out-of-town and abroad of what they will encounter. Changing, for example, the frequency at which the lights change is not just a technological engineering question, but also requires political value judgements about the consequences for different parties (drivers, cyclists, pedestrians) as well as weighing environmental issues such as the merits of enabling faster traffic flows within cities versus discouraging motorists from creating visual, noise and emissions pollu- tion. Accounting standard setting faces comparable non-technical issues (Gerboth, 1973). 10. Researchers have differed in their interpretations of how to measure the degree of compara- bility between different countries’ domestic accounting standards and IFRS and/or US GAAP (e.g. Bae, Tan, and Welker, 2008; Horton & Serafeim, 2010; Brochet et al., 2014; cf. Barth et al. 2014). 11. With respect to individual standards, Horton, Serafeim, and Serafeim (2013) identify indica- tions of both ‘comparability’ and ‘quality’ advantages in mandatory adoption of IFRS but again their comparability must include the increased uniformity. Serafeim (2011) shows that 90 Macve the availability of information providing greater comparability with respect to the underly- ing economics of the life insurance business (which may be interpreted as ‘quality’) – pro- vided outside the regime of IFRS accounting standards but constrained by other professional/industry rules (which also necessarily impose some degree of uniformity), and subject to independent assurance – has incremental value in reducing information asymme- try in the stock-market. Barth et al. (2014) find IFRS fair-value adjustments to be ‘value rel- evant’ for financial firms, which is consistent with Foster (1975) since one would expect the large holdings of financial instruments (in particular stock–market securities) by such firms to mean that it is likely that changes in the value both of their holdings and of their own share prices will be correlated through market-wide movements (i.e. the accounting amounts are what empirical researchers have labelled ‘value relevant’, which could also be defined as how well they are correlated with Hicks’s ‘No.1’ measurement of the income of a firm, i.e. the change in the value of the owners’ interest in the firm as a whole, or (assum- ing fully ‘strongly’ efficient markets) its overall stock-market return – cf. Bromwich, Macve, & Sunder, 2010). 12. Voltaire, La Béguele (Contes, 1772), line 2: ‘le mieux est l’ennemi du bien’ http://en.wiki quote.org/wiki/Voltaire (accessed 9 January 2014). However, standard setters also need to be aware that, in a ‘second best world’, fixing just one aspect of a problem may make the overall situation worse (Lipsey & Lancaster, 1956; see for example Macve, 2014a and Macve, in press (and the discussion of ESOs there)). 13. http://www.searchquotes.com/search/The_Triumph_Of_Hope_Over_Experience/. 14. Accounting is of course wider than financial accounting (it includes management account- ing, government accounting, and so on); and financial reporting is wider than financial accounting (it includes a vast range of a more timely management commentary (e.g. Lundholm & Van Winkle, 2006) which the main value of periodic audited, published accounts is to confirm and thereby discipline through ‘truing up’ (e.g. Ball, 2013) as far as that is achievable in an ongoing business). Therefore, in practice it may be difficult to per- suade preparers, users and auditors to emphasize this one objective at the expense of others, as they will have an eye to what they see as any other consequences of a change in IFRS (e.g. to their remuneration, to taxation, to maximum legal dividend distributions, to regula- tion of the industry, to public perceptions of their business behaviour etc. – e.g. Zeff, 1993). This is a source of much of the ongoing debates over ‘stewardship’, ‘conservatism’ etc. (cf. Christensen, 2010; IASB, 2013a; Macve, 2010a; Macve, in press) as well as over wider issues such as corporate environmental and social responsibility [‘CESR’] reporting (e.g. Macve & Chen, 2010). 15. As IASB (2013b, p. 11) puts it, they contain: ‘summarised information about recognised assets, liabilities, equity, income, expenses, changes in equity and cash flows, that has been classified and aggregated in a manner that is useful’ (my emphasis added). A better expres- sion would include ‘measured’ before ‘classified’ and ‘intended to be’ before ‘useful’. 16. Apart from pedantic changes like excluding dividends from the profit and loss account (or from liabilities until declared) and recognising ‘full’ goodwill on acquisitions rather than just the amount relating to the controlling interest – although here the IASB has diverged from FASB and allowed the alternative, more intelligible, ‘partial goodwill’ option to continue (e.g. Holgate & Gaull, 2005). 17. For example, IASB (2013a, 4.9 (c)) essentially repeats the existing justification for the ban on capitalising internal goodwill. 18. Extension to liabilities as ‘relief value’ is discussed in Horton, Macve, and Serafeim (2011); cf. Nobes (2011). 19. My emphasis added. 20. However it is important that the reporting of performance also enables investors (and others), and internally managers themselves, to evaluate the success of the management’s current ‘business model’ and senior management’s own explanations of how the business has performed and their strategy for the future, and where necessary challenge it. Cf. Beattie & Smith (2013). 21. What Barth (2013) labels as ‘modified historical cost’. 22. The problems may be mitigated, but far from eliminated, by having auditors with specialist industry expertise which is a factor favouring the market dominance of ‘Big 4’ auditors in China as elsewhere (e.g. Deng & Macve, 2013; cf. Chen & Zhang, 2010). China Journal of Accounting Studies 91 23. The potential for ‘Day 1’ profits under FV approaches was stated by IASB to have left Board members ‘uncomfortable’. Clearly a conceptual explanation of what degree of con- servatism in accounting is appropriate – and why – is one of the major issues that the CF should address (e.g. Lambert (2010); Horton et al. (2011); Macve (in press); cf. Nobes (2011)). Recognition of profiton ‘Day 1’ has also been the most controversial feature of the ‘Embedded Value’ method widely adopted for supplementary reporting by life insurance companies such as China’s Ping An (http://about.pingan.com/pinganxinwen/en/ 1395369892233.shtml [accessed 7 April 2014], as discussed by Serafeim (2011). 24. The list should be extended to distinctions between ‘realised’ and ‘unrealised’ and to include Hicks’s ‘maintainable (real) income’ (e.g. Bromwich et al., 2010). 25. Cf. Bhimani, Bond, and Sivabalan (2013). 26. As for example in the European Union where the binding regulation requiring all EU listed companies to report under IFRS ‘as adopted in the European Union’ has allowed various attempts at ‘carve-outs’ (e.g. Zeff, 2007b). Securing international agreement further intensi- fies the political problems faced within one jurisdiction (e.g. as discussed by Gerboth, 1973). 27. China’s latest accounting standards (under the control of its Ministry of Finance) still differ from IFRS but only with respect to items such as more restrictive application of FV and prohibition of reversal of all impairment losses on tangible and intangible fixed assets (Deloitte, 2006), presumably reflecting continuing caution about dangers of excessive mana- gerial manipulation (cf. Ball et al., 2003). See also KPMG (2011); Lee, Walker, & Zeng (2013). 28. The ‘Roadmap of continuous convergence between China Accounting Standards and IFRS’ (in Chinese only) can be obtained on the webpage of the China Accounting Standards Committee under the MOF (http://www.casc.gov.cn/ ). See also KPMG (2011). 29. ICAS & IFAC (2014) now discuss the option of a CF that ‘is more iterative and less deduc- tive’ where the CF ‘is a high-level map that highlights key features of the landscape but does not provide a basis for navigating the terrain. One would need to look at individual standards for that level of detail’ (ICAS & IFAC, 2014, p. 6). Again ‘whilst some concepts can be developed and advanced, in other areas we may have to settle on accepted conven- tions and norms’ (ICAS & IFAC, 2014, p. 16). This seems closer to the view argued long ago by Gerboth (1973). 30. There are various possible mechanisms for combining accounting standardisation (with its potential loss of relevant contextual information) with sufficient flexibility to allow more nuanced interpretation and understanding of financial reports and thereby greater ‘genuine’ comparability (see, for example, Edwards, 1938; Macve, 2010a). Issues relating to ‘informa- tion overload’ and/or inappropriate disclosures are reviewed in ICAEW (2013). New devel- opments in ‘sustainability’ reporting such as CESR and their impacts, which may be even more significant for the future, are beyond the scope of the IASB’s current CF revision pro- ject and therefore of this paper (cf. Guo & Du, 2010; Macve & Chen, 2010; Macve, in press). 31. Rotttenburg (2012) cites examples of constructions such as IQ (intelligence) and indices including HPI (poverty); HDI (development); RoL (rule of law); GII (gender inequality), all of which are central to ‘problem identification’ and then to economic and social policy- making, evaluation and research. Furthermore, the pressures to perform in various indices of ‘global university rankings’ also drive institutional priorities for types of academic research and publication (e.g. http://www.timeshighereducation.co.uk/world-university-rank ings/; http://www.shanghairanking.com/ (both accessed 12 January 2014) – cf. Ashton et al. (2009)). 32. Similarly, consolidated accounts of complex groups need complementing by relevant seg- mental disclosures. References Allen, A., & Ramanna, K. (2013). Towards an understanding of the role of standard setters in standard setting. Journal of Accounting and Economics, 55,1–66. Armstrong, C. S., Barth, M. E., Jagolinzer, A. D., & Riedl, E. J. (2010). 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Journal
China Journal of Accounting Studies
– Taylor & Francis
Published: Apr 3, 2014
Keywords: comparability; global financial reporting; International Financial Reporting Standards; Conceptual Framework; China
