ADVANCED CORPORATE REPORTING

Criticism of the IASB Joint Review of the Conceptual Framework



Criticism of the IASB Joint Review of the Conceptual Framework

Introduction

Controversial accounting pronouncements are not new to the accounting profession. The recent review of the conceptual framework has led to severe criticism on few of the concepts. The paper discusses two areas of criticism; Fair Value Accounting and Stewardship.

Discussion

Fair Value Accounting (FVA)

Involved and complicated accounting issues such as leases, deferred income taxes, pensions, and business combinations are, by nature, controversial; and despite the passage of standards related to these issues, some would still say that the underlying accounting questions are still unresolved. Yet there have been only a handful of accounting standards that have generated the degree of controversy as Statement of Financial Accounting Standard No. 157 (SFAS 157), Fair Value Measurements.

Critics argue that FVA fails to represent what it aims to represent. They argue that even the review has not looked into this crucial question. FVA has failed to provide the pertinent information to the primary users of financial statements—investors and creditors. These two groups are interested in the amount, timing, and uncertainty of cash flows; but fair value reports unrealized amounts that are not tied to cash flow. Fair value information should be carried at the present value of cash flows, or net income, to reflect the information desired by investors and creditors (Arya & Reinstein, 2010, pp. 2-10).

Further, FVA does not appropriately reflect the stewardship performance of management. Application of the “highest and best use” concept may not have anything to do with the business model and tends to reflect liquidation values instead of earning power. FVA, as presently reported, is not consistent with the day-to-day operating practices of management. Managers manage the central operations of the entity and not the fair value of the assets/liabilities on the balance sheet.

SFAC 8 seems to have been written to justify FVA, yet the elevation of faithful representation as a significant characteristic of useful accounting information is a positive change. Representational faithfulness should be the overriding qualitative characteristic of accounting information. For information to be representationally faithful, it should retain the character of the element of the financial statement, which implies a mixed-model approach. However, critic's points out that the current fair value methodology seems to be at odds with the concept of faithful representation.

FVA's balance sheet is in violation of SFAC 5, which states that traditional accounting emphasizes reporting the results of operations, and that financial position does not intend to depict the market value of the entity (AICPA, 2010, pp. 1-4). While FVA reports the results of market events in the financial statements, SFAC 5 calls for “earnings” to reflect the results of the transactions in which the business is engaged. SFAC 5 focuses on earnings tied to the central operations of the entity; instead, of managing the values of assets and liabilities.

Critics believe that the fair value model needs to be reevaluated. FASB should adopt a mixed model approach and should improve or refine the inputs used ...