The International Accounting Standards Board (IASB) has received strong support for the reintroduction of the concept of ‘prudence’ into its conceptual framework – but little clear direction on how it should do so.
According to a staff summary of comment letters on the board’s recently issued exposure draft, some three-quarters of respondents commented on plans to bring back an an explicit reference to prudence.
The IASB removed the concept from the 2010 iteration of its framework.
But whatever path the board takes on the issue over the course of its new deliberations, one board member warned it against “playing games” with words.
Speaking during the 15 March meeting, Patrick Finnegan said: “The problem we have right now is [that] the definition of ‘prudence’ in a dictionary … is more consistent with asymmetric prudence than it is with the IASB’s proposed definition.
“My advice is to describe what you mean more precisely. Don’t use a word imprecisely. Don’t say something is something that it is not. And that’s what we’re doing right now.”
His comments came as the London-based accounting rule-maker considered a staff summary of comments on its October 2015 exposure draft.
The board announced its conceptual framework project in 2011.
A discussion paper followed in July 2013.
The project is of keen interest to many long-term investors in the UK arguing that accounting standards should emphasise conservatism and caution.
In particular, they want to see more timely recognition of losses and a more cautious approach to assets – especially where there is measurement uncertainty over the availability of an asset.
The IASB received 233 comment letters on its latest exposure draft.
Staff reported that constituents generally viewed the conceptual framework project as ‘high priority’.
In particular, they saw the exposure draft as “a significant improvement on both the existing conceptual framework and the proposals in the discussion paper.”
The project is not a fundamental rework of the framework – rather it updates, clarifies and fills in gaps in the existing framework.
The early signs are that the board’s new deliberations in the coming months will focus on the tensions between prudence in the form of so-called cautious prudence or prudence as asymmetric prudence.
The IASB defined prudence in its exposure draft as caution when making judgements under conditions of uncertainty – but without exercising more caution when recognising gains and assets than losses and liabilities.
Under the competing asymmetric approach to prudence, a business would recognise losses sooner than it would recognise gains.
Fundamentally, the reintroduction of prudence – even as the IASB has currently defined it – could be expected to lead to the delayed recognition of gains where there is measurement uncertainty.
Nonetheless, a leading accounting academic and former IASB staffer slammed the proposals as being essentially meaningless.
In a 21 November comment letter, professor Richard Baker from Oxford University’s Said Business School wrote: “This approach is … fundamentally flawed. The reason is that it introduces a ‘concept’ into the framework that is not really a concept at all. At best, this achieves nothing – at worst, it leads to confusion.”
He added: “The problem is that prudence is in substance defined in a way that adds nothing to the concept of neutrality. As defined, prudence essentially means ‘make sure to be neutral’.
“Given that the framework defines neutrality already, there is nothing to be gained from the introduction of an additional ‘concept’ that has no distinctive meaning.”
The UK Financial Reporting Council has also called on the IASB to bite the bullet and adopt asymmetric prudence.
The reintroduction to the Conceptual Framework of a specific reference to prudence is very welcome.
However, the treatment of it in the exposure draft — as support for the idea of neutrality — is wholly inadequate.
“The essence of prudence is the idea referred to in the Basis for Conclusions as ‘asymmetric prudence’ — a lower threshold for the recognition of liabilities and losses than for assets and gains — which is absent from the text of the draft Conceptual Framework itself.”
The IASB is expected to fix the future strategy for finalising the conceptual framework project at its April meeting.
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