Statements welcoming the Monitoring Board's Statement of Principles were issued by the IASCF (which oversees the International Accounting Standards Board), and the Financial Accounting Foundation or FAF (which oversees the Financial Accounting Standards Board.) (See IASCF Statement; FAF Statement.)
Laying the groundwork for the principles, the Monitoring Board states:
- [W]e believe that the future strength and integrity of our capital markets depends on both regulators and accounting standard setters reaffirming, at this critical juncture, their commitment to certain fundamental first principles about the purposes that accounting standards serve, and the process by which the standards are determined.
- The quality of financial reporting, and, by extension, the health and integrity of our capital markets, depends upon vigilant attentiveness to these fundamental principles
- [E]xpedience should not be permitted to undermine the objectives these principles describe.
- [W]e also believe a reiteration of these principles, and an explanation for why they are so important, is a valuable exercise given that there have been calls from some quarters for accounting standards to be reformed in ways that could decrease the transparency of public company financial statements, particularly with regard to disclosures of certain types of financial assets made by financial institutions that sell their shares to the public.
- While we recognise that some observers have claimed that certain current accounting standards impose procyclical burdens on some financial institutions that have publicly traded shares by requiring that these issuers use market-based or otherwise objective and verifiable measures to report to investors the current value of the assets they hold, we believe this claim focuses on a symptom of a problem rather than the problem itself. [NOTE: See cent one under 'my two cents' at the bottom of this post.]
- Public capital markets, however, are predicated on trust and transparency. Investors trust that an issuer’s disclosure statements, and the accounting standards on which they are based, provide them with a complete, unbiased, fair and comparable view of the issuer’s performance.
- If that trust is undermined through promulgation of new accounting standards that offer less transparency (for example, by indicating that an investment involves less risk than actually exists), or that are established through a process that deviates from fundamental principles guiding the standard setter’s decisions, investor confidence in our capital markets will suffer, with strong and weak issuers alike facing concomitantly greater capital costs.
Additionally, the Monitoring Board weighs in on the debate about bank regulatory reporting vis-a-vis generally accepted accounting principles:
While it is useful to consider the intersection of banking supervision and financial reporting in light of the recent banking crisis, accounting standards should not be allowed to become a surrogate for robust bank risk management or effective bank supervision. Accessing public capital markets is a choice issuers make, and but one of many choices open to financial institutions. As securities market regulators, we believe it would be a mistake to attempt to rectify today’s banking crisis by placing a burden on the investors in our public capital markets. Accounting standards must be designed to provide investors with information to assist them in efficiently allocating their hard-earned investment money. It is in this context that accounting standards are designed to contribute to a sound, prosperous and more stable financial standard of living.
Principles of Accounting Standards
The Monitoring Board identifies four broad principles which it states are common to the IASCF's and FAF's Conceptual Frameworks. Specifically, the Monitoring Board says, "We view the primary objective of financial reporting as being to provide information on an entity’s financial performance in a way that is useful for decision-making for present and potential investors. To be considered decision-useful, information provided through the application of the accounting standards must, at a minimum, be:
- understandable, and
The Monitoring Board defines all these terms in its Statement of Principles. For example, the term 'reliable' is defined by the Monitoring Board as:
Reliable:Information should be reliable in the sense of providing a faithful representation of the events on which it purports to be reporting. This requires the information to be neutral and to depict fairly the reported transactions. Reliability does not necessarily equate with certainty, as judgment, for example for some measurements or estimates of future outcomes, is an inherent aspect of financial reporting.
Regarding the four principles above for accounting standards, the Monitoring Board says: "These attributes are not controversial and enjoy broad support." [Note: see cent two under 'my two cents' at the bottom of this post.]
Principles for Accounting Standard-Setting
Importantly, the Monitoring Board describes not only principles for accounting standards, but also principles for the accounting standard-setting process itself. Specifically, the Monitoring Board states:
"Confidence in the quality and integrity of the standards depends upon independence and transparency in the standard setter’s due process."
These terms are defined by the Monitoring Board as follows:
Independence: Deliberations and, in particular, conclusion on positions in an independent fashion rely on a number of factors.
- First, the individuals composing the standard setting body must demonstrate professional competency in matters of financial reporting.
- Further, members with a decision-making role in the standard setting organisation should collectively be reasonably representative of the constituents whose interests the standards seek to address.
- Finally, the process should remain free of undue pressures from political and corporate interests.
- Visibility into the standard setting process should be sufficient to enable users to trace the evolution of the standard from thoughtful consideration of alternatives to final positions.
- Interested parties must be afforded the opportunity to provide input to inform the standard setter’s evaluation of pertinent issues
Tie-In To G-20 Meeting
The Monitoring Board's Statement of Principles, while aimed at the IASCF, sets forth principles that are fundamental to and consistent with those of both the IASCF (and in turn, the IASB) and the FAF (and in turn, FASB). As cited further above, both the IASCF and FAF issued statements welcoming the principles issued by the Monitoring Board.
It is noteworthy that the Monitoring Board's Statement of Principles was published a couple days ahead of the G-20 meeting taking place Sept. 24-25, 2009 in Pittsburgh, PA. The statement issued by the IASCF observed:
"The Trustees recently wrote to the G20 leaders, who are meeting later this week in Pittsburgh, to emphasise ‘the Trustees and the IASB are committed to taking all of the actions necessary within their sphere of responsibility to deal with the issues arising from the financial crisis.' The Trustees believe that the fundamental principles outlined by the Monitoring Board provide an important contribution in reminding the Trustees, the IASB, and stakeholders of the important role that accounting standards play in the functioning of capital markets and the economy at large."
We will report on the results of the G-20 meeting in a separate post.
My two cents
(I remind you of the disclaimer which appears on the right side of this blog.)
Cent 1: Although the G-20 and other international organizations have called for counter-cyclical measures, the Monitoring Board references procylicality indirectly, by stating: "[S]ome observers have claimed that certain current accounting standards impose procyclical burdens ... by requiring ... use [of] market-based or otherwise objective and verifiable measures to report to investors the current value of the assets they hold, we believe this claim focuses on a symptom of a problem rather than the problem itself." The Monitoring Board continues: "Public capital markets... are predicated on trust and transparency. Investors trust that an issuer’s disclosure statements, and the accounting standards on which they are based, provide them with a complete, unbiased, fair and comparable view of the issuer’s performance."
I would note that, although FAS 157, Fair Value Measurement (as referenced in the pre-Codification nomenclature) is based on a 'market participant' view, many of the questions raised with respect to FAS 157 have had to do with the fact that, particularly for 'level 3' assets that lack an active market (or any market at all), a 'market-based' value computed in accordance with FAS 157 may be a 'hypothetical' market-based value, which is not as 'objective' or 'verifiable' as the words above would suggest, and the lack of 'objective, verifiable' market-based measures has been one of the issues raised with respect to requirements for a 'market-based' value vs. e.g. a discounted cash flow based value, particularly in thinly traded or disorderly markets.
The issue with respect to the next sentence noted by the Monitoring Board, referencing investors' desire for 'complete, unbiased, fair and comparable' information, is that some would question if 'market-based' values in thinly traded or disorderly markets meet the criteria of being 'complete, unbiased, and fair' although they could be 'comparable' if, e.g the only quotes available are comparable fire sale prices in a market driven by fear and illiquidity.
Cent 2: I would agree that the four principles for accounting standards outlined by the Monitoring Board (reliable, relevant, understandable and comparable) are 'not controversial' in and of themselves (i.e. as single words), but when you read the Monitoring Board's definition of Reliable cited above, some readers may wonder why the definition does not mention 'verifiability.' (Although, interestingly, the word 'verifiable' is used elsewhere in the Monitoring Board Statement as noted above, but not in the principles themselves, and most significantly not in the definition of Reliable.)
People raising the question about the absence of 'verifiable' within the definition of 'reliable' may base their question on the fact that the traditional definition of 'reliable' as originally constructed under FASB's Concepts Statement No. 2 included not only 'representational faithfulness' as a cornerstone of reliablity, but also that 'verifiability' is a fundamental facet of reliabilty as well. (A useful article on the longstanding definition of reliability (including with respect to verifiability) - and how reliabilty was traditionally balanced with relevance in FASB Concepts Statement No. 2, can be found in Relevance and Reliability, by L. Todd Johnson, originally published in The FASB Report, Feb. 28 ,2005.)
However, those who have been following the development of a revised and converged FASB and IASB Conceptual Framework over the past few years, (for an explanation, see, e.g. Revisiting the Concepts - A New Conceptual Framework Project, by Halsey Bullen and Kimberley Crook, May, 2005) have noticed that, e.g., FASB proposed a change in the definition of 'reliability' by removing 'verifiability' from that definition (another way of looking at it is, by removing 'verifiability' from the definition of 'representational faithfulness,' which is part of 'reliability.')
Why does verifiability (and its corollary, auditability) matter in deeming something 'reliable'? It is one part of the balancing exercise in weighing, e.g. the relevance vs. reliability of two measurement methods, say, fair value and amortized cost, along with other considerations such as cost-benefit, compability and understandability, in determining the proper accounting standard.
As noted further above, the Monitoring Board said in its statement this week that the principles it describes are 'not controversial' and 'enjoy broad support.' However, a review of comment letters submitted on the FASB Discussion Paper/Preliminary Views and subsequent Exposure Draft on the Conceptual Framework - Qualitative Characteristics of Financial Reporting, illustrates that there has been some disagreement among constituents about the proposed removal of 'verifiabilty' from the definition of 'reliability.' (And as noted above, the Monitoring Board's definition of 'reliable' tracks that of the proposed revision to FASB's Conceptual Framework which no longer includes 'verifiable' as part of 'reliable,' rather than the original definition of 'reliable' dating back to Concepts Statement No. 2, which included 'verifiability').
Here are some excerpts from some comment letters on the Exposure Draft to amend Con 2:
Basel committee: We note that the Board now considers the concept of “verifiability” as an enhancing qualitative characteristic and no longer regards it as a required component of “faithful representation”. We do not believe that such a change better conveys the importance of this characteristic and we continue to encourage the Board to expand the portion of the definition provided in paragraph QC20(b). In this regard, this portion of the definition should state that the selected recognition or measurement method, notably for highly illiquid products, should not only be applied properly, but should also be deemed reasonable based on the available evidence. In carrying out our supervisory responsibilities, we insist that the recognition and measurement methods included in banks’ reporting policies and procedures be reasonable and properly applied in their internal financial statement preparation processes.
Staff of the Accounting Standards Board of Canada: Some Advisory Group members question the removal of verifiability from faithful representation. They think that if information is not verifiable, its freedom from material error cannot be determined. To make freedom from material error operational, we think that an explanation is needed of how it can be assessed when it is not verifiable.
PCFRC (FASB-AICPA Private Co. Financial Reporting Committee): The PCFRC believes that relevance, faithful representation, comparability,verifiability, timeliness, and understandability are all essential qualitative characteristics that make financial information useful. These characteristics should not be separated and categorized as either fundamental or enhancing qualitative characteristics. Relegating comparability, verifiability, timeliness, and understandability to secondary importance behind relevance and faithful representation diminishes the perceived importance of those four essential characteristics. Labeling comparability, verifiability, timeliness, and understandability as complementary to relevance and faithful representation fails to do justice to the important role that those four characteristics play in the usefulness of financial reporting. Moreover, the separation of qualitative characteristics into two categories may be unnecessarily distracting and academic.
NYSSCPA comment letter: We believe the fundamental qualitative characteristics are understood and useful. However, we note that the Boards have determined to make relevance the primary characteristic, elevating this quality above faithful representation as indicated in QC 13. The decision to sacrifice degrees of faithful representation (referred to as reliability and verifiability) for relevance (referred to as usefulness) has been reflected in recent years in actual standard setting. The trend has been toward a greater use of fair value, estimates, projections and subjective intent to develop and quantify historical financial data. We believe that this “trade-off” needs to be addressed directly as standards are set. This discussion should be formally documented in the “basis for conclusions” in everyaccounting standard for which this trade-off is a significant issue.
FEI Committee on Corporate Reporting comment letter on 2006 Discussion Paper: [W]e believe there should be a more robust discussion of the relative importance of verifiability in the determination of whether an item is a faithful representation of an underlying economic phenomenon. Without a more robust discussion, we are concerned that, by default, fair value will always be considered the measurement objective that most faithfully represents any economic phenomenon, a position with which we strongly disagree.
Aside from the 2 points raised above ('cent one' and 'cent two'), I do applaud the Monitoring Board's Statement of Principles not only for including reasonable principles, but doing it in a succinct way. And I believe it is particularly noteworthy that 'transparency' of the standard-setting process was emphasized along with independence, because just as some say financial reporting should not be a 'black box,' the same would hold true for the standard-setting process; sunshine boosts confidence.
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