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Conceptual Framework Revisions: Say

Goodbye to “Reliability” and “Stewardship”

Elaine Henry and Oscar J. Holzmann

INTRODUCTION seems oddly out of sync with the is presented in concepts state-
standard-setting activity aimed ments, which are not part of the
In September 2010, the at converging US and interna- FASB’s Accounting Standards
Financial Accounting Standards tional accounting standards, Codification (the single source
Board (FASB) and the Inter- which has been proceeding vig- of authoritative US GAAP).
national Accounting Standards orously. Logically, one would Similarly, the IASB’s Conceptual
Board (IASB) issued updates to expect that establishing the goals Framework for Financial Report-
the conceptual frameworks of of an endeavor and its concep- ing2 is not an IFRS. Note, how-
US generally accepted account- tual foundation would precede ever, that the IASB framework
ing principles (GAAP) and and determine all other actions is part of the IFRS hierarchy of
international financial reporting related to the endeavor. However, accounting rules, as described
standards (IFRSs), respectively. the presumption is that if the in paragraphs 10 through 12 of
The updates are part of the joint Boards had waited until comple- International Accounting Stan-
FASB/IASB project aimed at tion of the conceptual framework dard 8, Accounting Policies,
developing an improved, com- project, other standard-setting Changes in Accounting Estimates
mon framework. The framework activity aimed at converging US and Errors. The IFRS hierarchy
project, which was begun in and international accounting provides that when a transaction
October 2004, is designed to be standards would have been unac- is not specifically covered by an
implemented in eight phases, ceptably delayed. IFRS, a preparer can consult, in
three of which are currently on In this column, we discuss descending order: another IFRS
the active agendas of the FASB the context of the conceptual for a similar transaction; the
and IASB, and only one of framework generally and then IASB framework; and, finally,
which has now been completed.1 recently issued updates, the first pronouncements by other stan-
The FASB’s update is of which deals with the objective dard setters that use a similar
presented in the Statement of of financial reporting and the conceptual framework.
Financial Accounting Concepts second with the qualities of use- While the frameworks are
No. 8 (SFAC 8), Conceptual ful financial information. not part of accounting standards,
Framework for Financial Report- they do serve to describe the
ing, which replaces SFAC 1 CONCEPTUAL FRAMEWORK— objectives and concepts under-
and 2. The stated purpose of CONTEXT pinning the standards. As such,
the conceptual framework is to the frameworks directly benefit
establish the objectives to guide The conceptual frameworks the Boards in their standard-set-
the Board’s reasoning when are not part of the authorita- ting role. In addition, the FASB
considering accounting and tive accounting standards issued indicates that the framework will
reporting alternatives. Given its by the FASB or IASB. The US also benefit “those affected by
purpose, the framework project GAAP conceptual framework or interested in” the standards;
© 2011 Wiley Periodicals, Inc.
Published online in Wiley Online Library (wileyonlinelibrary.com).
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 92
and the IASB indicates that its
framework will assist national
standard setters, preparers, audi-
tors, and users.
THE OBJECTIVE OF GENERAL
PURPOSE FINANCIAL
REPORTING: CHAPTER 1
Chapter 1 of SFAC 8 super-
sedes FASB’s SFAC 1, Objec-
tives of Financial Reporting
by Business Enterprises, and
includes various changes to both
US and international standards.
As with SFAC 1, the scope of
the conceptual framework cov-
ers financial reporting, not just
financial statements. The con-
verged scope is a change for
international standards, however,
where previously the IASB
framework applied only to finan-
cial statements.
The objectives of finan-
cial reporting in the updated
frameworks, Chapter 1, take the
perspective of capital providers
(existing and potential investors,
lenders, and other creditors) as
the primary user group. Specifi-
cally, the framework provides
that:
The objective of general
purpose financial report-
ing is to provide finan-
cial information about
the reporting entity that
is useful to existing
and potential inves-
tors, lenders, and other
creditors in making deci-
sions about providing
resources to the entity.
Those decisions involve
buying, selling, or hold-
ing equity and debt
instruments and provid-
ing or settling loans and
other forms of credit.3
The focus on a primary user
group was deemed necessary to
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The Journal of Corporate Accounting & Finance / March/April 2011
avoid producing a framework
that would be too vague to be
useful. The Boards chose capital
providers as the primary user
group for three reasons: (1) this
group has the most critical and
immediate need for informa-
tion, (2) the Boards are required
to focus on the needs of capital
market participants, and (3) the
information needed by this group
would likely meet most of the
needs of other user groups.4
Capital providers use finan-
cial reporting to assess cash-flow
prospects and also to assess
management’s fulfillment of its
stewardship responsibilities. The
Boards were careful, however,
to avoid including language that
sounded like there were two
objectives rather than a single
objective of financial reporting.5
Thus, the single objective is to
provide decision-useful informa-
tion, and the frameworks indi-
cate that decisions relate both
to resource allocation and to
stewardship evaluation. The basis
for conclusions implies that the
standard setters view these uses
as equally important:
The Board did not intend
to imply that assessing
prospects for future cash
flow or assessing the
quality of management’s
stewardship is more
important than the other.
Both are important for
making decisions about
providing resources to an
entity, and information
about stewardship is also
important for resource
providers who have the
ability to vote on, or oth-
erwise influence, man-
agement’s actions.6
The relative importance of
assessing cash-flow prospects
versus assessing management’s
stewardship has been debated
in the accounting literature sur-
rounding the conceptual frame-
work process. For example, the
Financial Accounting Standards
Committee (FASC) of the
American Accounting Associa-
tion (AAA) explicitly criticized
the preliminary view of the
conceptual framework for de-
emphasizing the stewardship
role of accounting information
by not including it as a separate,
explicit objective.7
Interestingly, the newly
issued updates do not even
include the term stewardship.
The Basis for Conclusions
indicates that the term was
excluded because of difficulty
in translating it into other lan-
guages. Instead, the updated
framework refers to “how
efficiently and effectively the
entity’s management and gov-
erning board have discharged
their responsibilities to use the
entity’s resources.”8
QUALITATIVE CHARACTERISTICS
OF USEFUL FINANCIAL
INFORMATION: CHAPTER 3
The second chapter in the
new pronouncement is labeled
Chapter 3, leaving the concep-
tual framework with an odd—
hopefully temporary—gap in its
numbering. Chapter 2 is being
reserved for a chapter on the
reporting entity. The Exposure
Draft for the Chapter 2 topic was
issued in March, with a comment
period that ended in July 2011.
Chapter 3 of SFAC 8 super-
sedes FASB’s SFAC 2, Qualita-
tive Characteristics of Account-
ing Information. The updates
specify that the two fundamental
qualitative characteristics of
useful financial information are
relevance and faithful represen-
tation.9 The so-called enhanc-
ing qualitative characteristics
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 The Journal of Corporate Accounting & Finance / March/April 2011
are comparability, verifiability,
timeliness, and understandabil-
ity. The update treats materiality
as it has been treated in IFRSs:
an aspect of relevance. Thus,
including materiality as a com-
ponent of reliability is a change
for US GAAP, where materiality
had previously been character-
ized as a constraint, but not for
IFRSs.
The updates replace the term
reliable with the term faithful
representation—a change for
both US GAAP and IFRSs. The
Boards decided to use the new
term because it had not been
possible to explain successfully
the meaning of reliable, with
people variously interpreting
reliable to mean verifiable, free
from material error, neutral,
precise, faithful representation,
or some combination of these
terms.10 The concept of faith-
ful representation subsumes
the concept of substance over
form, a concept that previously
appeared in the IASB framework
as a separate characteristic but
has now been excluded because
of its redundancy with faithful
representation.
The characteristics of finan-
cial reporting that faithfully
represents economic phenomena
are as follows: complete, neu-
tral, and free from error.11 The
aim for neutrality means that the
conceptual frameworks explic-
itly exclude conservatism and
prudence as desirable character-
istics of financial reporting. The
relative desirability of neutrality
versus conservatism has been
the topic of debate in accounting
research. Some have cautioned,
for example, that eliminating
the concept of conservatism as
a desirable characteristic will
impair the usefulness of finan-
cial information.12 However, the
Boards conclude that neutrality
is the paramount characteristic
© 2011 Wiley Periodicals, Inc.
JCAF20679.indd 93
and is inconsistent with either
conservatism or prudence.
THE SUBTEXT? FAIR VALUE
VERSUS HISTORICAL COST
Several changes in the con-
ceptual framework that appear
subtle are arguably much more
significant when viewed in the
context of the debate between
fair value and historical cost
as a basis for measurement of
assets. First, the updates replace
reliability as a desirable char-
acteristic of financial report-
ing. The stated reason is that
it was not possible to explain
the meaning of reliable, so the
term faithful representation is
used instead. Broadly speaking,
proponents of historical cost
claim that historical cost is more
reliable than fair value, primar-
ily because it is based on audit-
able records of amounts paid
to purchase an asset rather than
on fair value (often estimated
based on the asset’s future cash
flows). In contrast, proponents
of fair value claim that fair value
is more relevant than historical
cost. The fair value/historical
cost debate is, in some ways,
encapsulated in those two words:
reliable versus relevant. With
reliability no longer specified as
a desired financial characteris-
tic, proponents of historical cost
have lost a fundamental basis
for their argument—albeit a
semantic one.
Similarly, the updates explic-
itly avoid the term stewardship
in the objectives of financial
reporting. The stated reason
is difficultly in translating the
word into other languages, and
the longer phrase mentioned
earlier is used instead. Broadly
speaking, some proponents of
historical cost have claimed
that assessment of manage-
ment’s stewardship is the most
93
important objective of financial
reporting and that historical cost
is more useful than fair value in
assessing management’s steward-
ship. With stewardship no longer
an objective of financial report-
ing, proponents of historical cost
have lost another fundamental,
if semantic, basis for their
argument.
Finally, the updates eliminate
conservatism and prudence as
desirable characteristics of finan-
cial reporting. Both are viewed
as conflicting with the desired
neutrality. Some proponents of
historical cost (including related
measurement practices such as
lower-of-cost-or-market) claim
that historical cost is more con-
servative than fair value, which
permits the values of assets to
be written up as well as written
down. An argument in favor of
conservatism is that it prevents
inappropriate early distributions
to shareholders or management.13
In the updated frameworks, con-
servatism is no longer a desired
financial characteristic. Here,
proponents of historical cost
have lost another fundamental
basis for their argument, and
this one goes beyond semantics.
Overall, with the updates to the
conceptual framework, several
debate-laden words disappear
down the drain of accounting
history.
CONCLUSION
The updates to the concep-
tual framework were accepted
by unanimous vote of the FASB.
News of the Boards’ issuance of
the new concept statement did
not merit attention in the main-
stream financial media (the pre-
mature resignation of the FASB
chairman was considered more
newsworthy). Yet arguably, the
changes in the framework have
significance beyond what might
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 94 The Journal of Corporate Accounting & Finance / March/April 2011

be widely understood and may
represent a final shot in a battle
between fair value and historical
cost.
NOTES
1. Conceptual Framework—Joint Project
of the IASB and FASB, Project Informa-
tion Page, as updated through November
1, 2010. Available at http://www.fasb
.org.
2. Conceptual Framework for Financial
Reporting 2010, issued by the IASB in
September 2010, is available at http://
www.iasb.org. The prior version was the
IASB’s Framework for the Preparation
and Presentation of Financial State-
ments 1989.
3. SFAC 8, ¶OB2. Previously, US GAAP
had provided: “Financial reporting
should provide information that is use-
ful to present and potential investors
and creditors and other users in making
rational investment, credit, and similar
decisions” (SFAC 1, ¶34). International
rules had provided: “The objective of
financial statements is to provide infor-
mation about the financial position,
performance and changes in financial
position of an entity that is useful to a
wide range of users in making economic
decisions” (IASB Framework 1989,
¶12).
4. SFAC 8, ¶ BC1.16.
5. Refer to the IASB staff paper “Sweep
issues from the ballot draft” dated May
18, 2010.
6. SFAC 8, ¶ BC1.27.
7. American Accounting Association’s
Financial Accounting Standards Com-
mittee. (2007). The FASB’s conceptual
framework for financial reporting: A
critical analysis. Accounting Horizons,
21, 229–238. See also O’Connell, V.
(2007). Reflections on stewardship
reporting. Accounting Horizons, 21,
215–227.
8. SFAC 8, ¶ OB4.
9. Previously, US GAAP had provided
that relevance and reliability are the two
characteristics that make financial infor-
mation useful (SFAC 2).
10. SFAC 8, ¶ BC3.24.
11. SFAC 8, ¶ QC12.
12. See for example, LaFond, R., & Watts,
R. L. (2008). The information role of
conservatism. The Accounting Review,
83, 447–478. Watts, R. L. (2003).
Conservatism in accounting Part II:
Evidence and research opportunities.
Accounting Horizons, 17, 287–301.
13. Watts, R. L. (2006). What has the invis-
ible hand achieved? Accounting & Busi-
ness Research, 36, 51–61.

Elaine Henry, Ph.D., CFA, is an Assistant Professor of Accounting at the University of Miami, where she
teaches courses in financial statement analysis, valuation, and international financial accounting stan-
dards. Professor Henry is a member of the American Accounting Association, the International Association
for Accounting Education & Research, the Harvard Business School Club of South Florida, and CFA Miami.
Oscar J. Holzmann, PhD, is an associate professor of accounting at the University of Miami, where he
teaches financial accounting and financial statement analysis courses. Professor Holzmann received his BA
in economics from Gannon University and an MS and PhD in accounting from the Pennsylvania State Uni-
versity. He has won teaching awards, has been published in academic and professional journals, and is one
of four accounting experts performing final reviews of the Spanish-language translation of the pronounce-
ments of the International Accounting Standards Board. He chairs the board of directors’ audit committee
of BFC Financial Corp., parent company of BankAtlantic Bancorp and Levitt Corp. Professor Holzmann is a
member of the American Accounting Association and the Institute of Internal Auditors.

DOI 10.1002/jcaf © 2011 Wiley Periodicals, Inc.

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