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ABACUS, Vol. 50, No. 1, 2014 doi: 10.1111/abac.12024

GNTHER GEBHARDT, ARACELI MORA, AND

ALFRED WAGENHOFER

Revisiting the Fundamental Concepts

of IFRS

When the International Accounting Standards Board (IASB) succeeded the Inter-
national Accounting Standards Committee (IASC) in 2001, it took over from its
predecessor not only a set of accounting standards, but also the Framework that was
published in 1989. In 2004, the IASB and the United States (U.S.) Financial Account-
ing Standards Board (FASB) began, as part of their convergence project, with
deliberations to revise their conceptual frameworks.1 The scope of that project was
limited, as in the view of the boards only some refining of language, filling of gaps
(e.g., measurement), and updating was needed. The plan was to discuss framework
issues separately in eight different project phases.
Changes in language, however, were soon perceived as changes in substance when
the boards issued as an outcome of the first phase a discussion paper (IASB, 2006)
and an exposure draft (IASB, 2008) on the chapters on objectives and qualitative
characteristics. The proposed changes appear to have been influenced strongly by
the U.S. environment, with a strong emphasis on the uses of accounting information
by capital market participants. As IFRS are applied in many countries with different
accounting traditions and uses of accounting information, the proposals were vividly
discussed. This discussion was also highlighted in an Abacus Open Forum held as an
initiative of the European Accounting Associations Financial Reporting Standards
Committee (EAA FRSC) at the Fourth EIASM Siena Workshop on Accounting
and Regulation in September 2007.2
In September 2010 the IASB and the FASB issued a revision of two sections of the
Conceptual Framework on the objectives of general purpose financial statements
and the qualitative characteristics of useful financial information. The urgency of
their work on other projects in the aftermath of the financial crisis led the two boards
to temporarily suspend further work on the Conceptual Framework. In 2012, the
IASB restarted its deliberations as an IASB project only, following the outcome of
a public agenda consultation in 2011, which placed high priority on finishing the

Gnther Gebhardt ([email protected]) is Professor of Accounting and Auditing, Goethe

University of Frankfurt, Germany; Araceli Mora ([email protected]) is Professor of Accounting
and Finance, University of Valencia, Spain; Alfred Wagenhofer ([email protected]) is
Professor of Accounting, University of Graz, Austria.
The authors particularly thank Peter Clark of the IASB for his useful comments.
1
In this paper, we distinguish between general discussions of framework issues by using lower case
letters and discussions of the IASB Conceptual Framework, for which we use capital letters.
2
See the report by Gebhardt and Dean (2008) and the follow-up paper by Peasnell et al. (2009).

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Conceptual Framework. The IASB decided to abandon the former phased approach
and to develop the Conceptual Framework in a single project and within a remark-
ably challenging time frame. Another Symposium on the Conceptual Framework
was scheduled at the Siena Sixth EIASM Workshop on Accounting and Regulation
in July 2013 to discuss the project. This proved to be timely as the IASB issued a
Discussion Paper on the Conceptual Framework (IASB, 2013, henceforth referred
to as the DP) only two weeks later for public comment.3
The present paper summarizes the discussions and views presented in this Sym-
posium on a number of important issues that are raised in the DP. The aim is to
contribute to the current debate on these issues, which lie at the heart of financial
reporting. We begin with the role of the Conceptual Framework and then discuss
the IASBs decision to build on, rather than reconsider, the conclusions it reached
when it revised the Conceptual Framework in 2010. We particularly revisit objec-
tives of financial reporting and prudence. The DP proposes changing the definition
of assets and liabilities and the recognition principle, particularly as to dealing
with uncertainty. We also briefly touch on derecognition and measurement. The
Symposium did not cover other important issues, such as the distinction between
equity and liabilities, principles of presentation and disclosure, and the conceptual
underpinning of other comprehensive income. Therefore, we do not cover these
issues here either.

ROLE OF THE CONCEPTUAL FRAMEWORK

A basic question is whether a conceptual framework should serve as a basis for

deductive reasoning or whether it is just an attempt to rationalize existing standards.
The DP is explicit in that the Conceptual Framework should include a set of
concepts and principles to be used primarily by the IASB in developing or revising
standards. While this view is understandable, it is almost unavoidable that conflicts
arise between the Conceptual Framework and new or revised standards designed to
meet the objectives of financial reporting (DP 1.32) because business transactions
and the economic environment evolve over time and standards need to react to
these developments. An ideal framework needs to be sufficiently flexible to promote
the evolution of standards. Thus, it should be comprehensive, but not too detailed in
its prescriptions.
Aside from spelling out a set of concepts and principles, in the actual application
of IFRS the Conceptual Framework has a subordinated role: if there is a conflict
between a standard and the Conceptual Framework, the standard generally prevails.
The DP proposes not to change this priority. It should be noted that in a number of
jurisdictions (e.g., in Continental European countries) fundamental principles are so

3
Panel members were Araceli Mora (University of Valencia and European Financial Reporting Advi-
sory Group, Technical Expert Group); Alberto Giussani (Organismo Italiano Contabilit); Peter Clark
(Director of Research, IASB); Alfred Wagenhofer (University of Graz and Austrian Financial Report-
ing and Auditing Committee); Chair: Gnther Gebhardt (Goethe Universitt Frankfurt). The panel
members thank the IASB for having made a ballot draft available in preparing for the Symposium.

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important for the interpretation and application of standards that there can be
situations that allow or even require the overriding of particular standards to
achieve the primary objective of financial reporting.4
The prioritization in the DP may create tensions when it comes to the application
of IFRS. For example, while prudence was removed from the qualitative character-
istics in the 2010 revision of the Conceptual Framework, it is still prevalent in many
existing and new IFRS. Would filling a gap in IFRS need to avoid any conservative
accounting policy? Consistency between standards and the Conceptual Framework
is desirable,5 but with the proposal of retaining a subordinated role for the Concep-
tual Framework conflicts seem to be inevitable. Raising the status of the Conceptual
Framework and requiring an override of existing standards should be carefully
considered.

OBJECTIVES AND USES OF FINANCIAL REPORTING

A fundamental issue addressed in the Framework is the objectives and uses of

financial reporting. The revised Conceptual Framework defines decision usefulness
to capital providers as the overarching objective and notes that information to meet
this objective also includes information to assess how efficiently and effectively the
entitys management and governing board have discharged their responsibilities to
use the entitys resources (Conceptual Framework, para. OB4).6 This means that
stewardship is only a secondary objective. The Conceptual Framework also contains
no discussion of potential conflicts between decision usefulness and stewardship,
suggesting that there are no conflicts between these objectives.7 This conclusion was,
and is, contentious, particularly in the European Union.8 The DP states that the
IASB does not want to revisit this issue again after the 2010 amendment. However,
as noted above, the 2010 Conceptual Framework was a joint project of the IASB and
the FASB, whereas the DP is a document developed by the IASB alone. Therefore,
there seems to be more room for further discussion. The objectives and uses are

4
See the true and fair view override as reconfirmed in Directive 2013/34/EU, para. 3. Livne and
McNichols (2009) study overrides in the U.K. It should be noted that IAS 1.19-24 contain a limited
overriding requirement under IFRS.
5
See Wstemann and Wstemann (2010).
6
For an analysis of the IASBs decision-making process on this issue see Pelger (2012).
7
The DP includes a few references to how efficiently and effectively the entitys management and
governing board have discharged their responsibilities to use the entitys resources. See, for example,
DP 6.10 on measurement and DP 7.33 on the notes.
8
The Accounting Directive 2013/34/EU, issued in June 2013, explicitly states that financial information
serves various objectives, including providing information for investors and giving an account of past
transactions and enhancing corporate governance, which requires striking an appropriate balance
between these objectives.

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fundamental to the development of principles of recognition, measurement and

disclosure in a framework.
There are multiple users, and multiple uses, of accounting information. To restrict
the focus to one important use may be conceptually appealing and facilitate the
development of standards, but it is not in line with the reality of how the standards
are in fact used, which requires accommodating diverging uses of financial informa-
tion. If the objectives are unlikely to lead to significant differences in accounting
standards, the issue would be moot. However, there has been research that shows
that the objectives of decision usefulness and stewardship may, but need not, be best
served by the same kind of accounting information.9 Intuitively, decision usefulness
is served by information useful to better forecast future cash flows, which is impor-
tant to improve price efficiency on the market. Stewardship, on the other hand,
requires information about management decisions taken under asymmetric infor-
mation, which helps improve economic efficiency, which often differs from price
efficiency. The following examples illustrate settings in which the two objectives can
lead to different conclusions.10
1. Level of verifiability. Investors can simply discount (or ignore) less verifiable
information, whereas contracts ex ante define the use of information, so verifi-
ability issues may eliminate contracting as an efficient mechanism to reduce
agency problems.
2. Transactions versus expectations. Past transactions are useful for decision useful-
ness in the sense that they can help assess future performance. For stewardship,
past transactions serve to assess if management fulfilled its goals or promises;
hence, accounting information that is built on past transactions is more important
for stewardship than for decision usefulness.
3. Transitory items. Transitory items are unlikely to be useful for decision usefulness
because they hinder forecasting. For stewardship, transitory items can provide
information about how management discharged its responsibilities directly or
indirectly, or if they are correlated with other information that is useful for that
objective.
4. Timeliness. Decision usefulness benefits more from timely information than stew-
ardship because stewardship values confirmatory information more than timely
provision of such information.
A major argument to not include stewardship as a separate objective in the 2010
revision of the Conceptual Framework is that users interested in stewardship are
viewed as being able to demand the information they need and use this information
in individual contracting. The IASB sees the function of financial reporting as
serving those users that must rely on public information and on standard contracts.
Many contracts, such as management compensation and debt contracts, indeed

9
See, for example, Gjesdal (1982), Paul (1992), and Drymiotes and Hemmer (2013).
10
The recent EFRAG (2013) Bulletin on Getting a Better Framework: Accountability and the
Objective of Financial Reporting includes more discussion and further examples.

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involve the use of financial information. However, an important deficiency of this

view is that it ignores contracting costs. Research shows that accounting information
is pervasively used in contracting, which suggests that contracting costs are substan-
tial and should not easily be disregarded in a framework.11 Regulators also use
financial information for regulatory purposes, despite the fact that the Framework
explicitly states that general purpose financial reporting is not designed to meet
specific regulatory uses of financial information. Again information cost is important
here.
Another issue is whether a framework should consider the institutional environ-
ment companies operate in. Listed companies are subject to extensive disclosure
requirements in most capital markets and there exist many other sources of infor-
mation about their performance (e.g., analyst reports) that are used in the market
to price the companys stocks and traded debt instruments. The issue is whether
accounting information should replicate or rather complement such information.12
This issue is particularly important because the Conceptual Framework is the basis
for IFRS that are also used by non-listed companies in many countries and for the
IFRS for Small to Medium-sized Entities (SMEs), which have different users and
uses of financial information to listed companies.

PRUDENCE

Whereas stewardship was only downgraded in prominence, prudence was removed

altogether in the 2010 revision of the Conceptual Framework because including
[it] would be inconsistent with neutrality (Conceptual Framework, para. BC3.27).
This decision by the IASB was at least as controversial as that on stewardship.
While the IASB argues that the reason for omitting the concept is related to trying
to be unambiguous and to avoid misinterpretations, others argue for the need to
explicitly reintroduce the concept of prudence in the Conceptual Framework.
There exist different types of prudence or conservatism distinguished in the aca-
demic literature.13 The value of conditional conservatism (news driven, ex post
conservatism), which provides unfavourable news in a more timely fashion than
good news, has drawn much attention in the literature. The value of unconditional
conservatism (news unrelated, ex ante conservatism), which measures assets at a
lower amount than their actual value and is mostly driven by regulation, is still a
matter of research.
Existing research suggests that conditional conservatism is important in debt
contracting.14 Empirical and analytical research shows that conservatism is valuable

11
See, for example, the survey in Armstrong et al. (2010).
12
See, for example, Christensen (2010).
13
See, for example, Basu (1997) and Garca Lara and Mora (2004).
14
See, for example, Holthausen and Watts (2001) and Ball et al. (2008).

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because it facilitates the monitoring of debt contracts and reduces the cost of
debt, facilitates the access to additional debt funds, and reduces risk shifting and
shareholderbondholder conflicts over dividends.15 Hence, conservatism is preferred
by debt holders either directly, or if they are price protected, it is preferred by equity
holders because they incur the residual agency cost. In empirical studies the poten-
tial value of conditional conservatism for equity holders has been analyzed, focusing
on adverse selection and on moral hazard, and shows that conservatism can reduce
agency costs and opportunities for earnings management.16 There is some, although
ambiguous, evidence on the increase of investment efficiency. Furthermore, there is
analytical research showing the potential benefits of conservatism in pre- and post-
contracting settings.17
The IASB argues that the concept of prudence has often been misunderstood
and that what some people consider prudence is often in fact earnings manage-
menta deliberate and opportunistic under- or overstatement of earningswhich
reduces the quality of the information. While this is a concern, the IASB could try to
re-introduce prudence (perhaps using caution instead) for dealing with high uncer-
tainty with a clear definition that separates the concept from opportunistic earnings
management. Empirical evidence also shows that conditional conservatism (as well
as earnings management) is mainly driven by institutional factors and is not neces-
sarily related to accounting standards. Differences in conditional conservatism
across countries and companies are likely to prevail, even with a common set of
standards. However, the Conceptual Framework could be a good way of encourag-
ing or incentivizing the type of conservatism that has been shown to create value for
capital providers.18 Moreover, the reintroduction of prudence in the Conceptual
Framework would provide a conceptual basis for the current and new standards,
most of which contain instances of prudent requirements.19

UNCERTAINTY IN RECOGNITION OF ASSETS AND LIABILITIES

The issue of how to deal with uncertainty arises in the DP particularly for the
definitions of assets and liabilities and in the principles guiding their recognition.The
DP distinguishes between existence uncertainty, which rarely arises in practice, and
outcome uncertainty, which is common. The DP proposes that, in contrast to the
previous framework, the definitions of assets and liabilities should not include
any particular probability thresholds, such as expected inflows and outflows of

15
See, for example, Zhang (2008) and Gx and Wagenhofer (2009).
16
See, for example, Garca Lara et al. (2009) and Hui et al. (2012).
17
See, for example, the survey in Ewert and Wagenhofer (2012).
18
See, for example, Garca Lara et al. (2005).
19
The paper by Barker and McGeachin (2013), which was presented at the workshop in Siena, gives an
extensive list of such requirements.

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economic benefits to avoid misinterpretation. It further proposes that there is also

no probability threshold for recognition, so that only relevance and the cost con-
straint can be invoked to prevent the recognition of highly uncertain assets and
liabilities. This proposal comes close to recognizing all economic assets and
liabilitieseven those with very low probability of obtaining or transferring eco-
nomic benefits, and it induces a symmetric recognition of a liability by one firm and
a corresponding asset by another firm. The DP opens up a discussion that was
brought to a halt with the attempt of the IASB to revise IAS 37 some years ago,
when it essentially proposed eliminating uncertainty from the recognition of provi-
sions and considering it in measurement only. In a way, the proposal in the DP
appears to apply the current accounting for financial instruments to all assets and
liabilities, whether financial or operative.
According to the DP the limit for recognition is not the uncertainty of the item,
but the irrelevance of the information or the cost of the information. The under-
standing of relevance will probably differ among board members and constituents as
well as across time, which may result in inconsistent decisions on standards and on
the application of standards. What is viewed as relevant today may not be relevant
tomorrow, as the discussion about inflation accounting has taught. Furthermore, the
IASB might be tempted to use such discretion to justify contestable recognition or
non-recognition in a standard.20

DERECOGNITION

Derecognition has been debated by the IASB and the FASB for a long time without
arriving at a solution. The current derecognition rules in IAS 39 and IFRS 9 use
several criteria and are difficult to apply. They may even lead to results that are
difficult to conceptualize. For example, a repurchase transaction may result in rec-
ognizing a financial asset that is not under the control of a seller or in not recognizing
a derivative for the forward contract.21
The DP discusses derecognition in the context of financial instruments and leasing
and describes possible approaches that have been used in prior standards. From
a conceptual perspective there is no need for special derecognition principles
in a conceptual framework. Formerly recognized assets or liabilities would be
derecognized when the definition of assets and liabilities or the recognition criteria
are no longer met. It is not yet clear whether the IASB aims at providing a (perhaps
inconsistent) basis for existing derecognition rules or whether it aims at developing
a clear principle for derecognition. Including specific derecognition rules in the
Conceptual Framework might give the standard setter more discretion in issuing a

20
To be fair, including prudence in the Framework offers similar discretion.
21
See, for example, the draft standard of the Joint Working Group of Standard Setters (2000), para.
3.26-28 and A.14-15, Reiland (2006) and Chircop et al. (2012).

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standard with complex derecognition rules without a need to describe and explain
departure from the recognition principles in the Conceptual Framework.

MEASUREMENT ISSUES

Another sweep issue is the distinction between recognition and measurement. Note
that the issue would become irrelevant if all rights (obligations) that induce positive
(negative) discounted cash flows are recognized as an asset (a liability) and mea-
sured at their expected value or fair value. The distinction is relevant, though, if
different measurement bases are considered appropriate. The DP includes a discus-
sion of cost-based measurements, current market prices including fair value, and
other cash-flow-based measurements. The DP does not propose a single measure-
ment base for all assets and liabilities, but suggests that the measurement base may
differ according to what measurement is most appropriate for capital providers to
assess a companys future cash flows. While the DP does not explicitly introduce a
business model concept (DP 9.23-34),22 the reference to the most appropriate infor-
mation about future cash flows depends on the expected use of the assets and
liabilities that are to be measured. If more than one measurement base is deemed to
be important to users, presentation of effects in profit or loss or in other compre-
hensive income (termed bridging items in the DP) could be used to capture the
benefits of both.
The discussion of measurement bases in the DP evolves around searching for
adequate criteria that could be used to select the most appropriate measurement
under given circumstances. The DP appears to contain different lines of arguments
that are not necessarily consistent across asset classes. For example, current exit
price is considered appropriate in most cases for financial instruments and traded
commodities because they yield cash flows through selling. In contrast, inventory is
considered similar to assets that are used and cost-based measurement is deemed
appropriate, noting that users are more interested in the margins, although the use
of inventory is to generate cash flows from selling. Margin information could also
be obtained from other measurement bases, such as current exit price. Moreover,
alternative bases, such as current cost and deprival value are not considered in the
DP in detail.
The DP contains discussions of several other important issues, for example, dis-
tinguishing liabilities from equity and reporting performance, which were also not
specifically addressed in the Symposium.
In general, the Symposium showed that there is a need and there will surely be
ample opportunities for a fruitful discourse between accounting academics and
standard setters on the fundamental issues that are addressed in the framework
development.

22
For a discussion of the business model see ICAEW (2010) and Leisenring et al. (2012).

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