The International Accounting Standards Board (IASB) has dashed the hopes of long-term UK institutional investors by rejecting calls to reintroduce ‘prudence’ defined as a bias toward conservatism back into International Financial Reporting Standards (IFRS).
Instead, the IASB appears set to reintroduce a more restrictive notion of prudence – so-called cautious prudence.
In an exposure draft on the project released last year, the IASB defined cautious prudence as the exercise of caution in conditions of uncertainty.
Some major UK investor interests have demanded the return of prudence because they believe it offers long-term investor interests a degree of protection.
This group has broadly supported what the IASB has labelled asymmetric prudence.
They believe this cautious approach to accounting will mean distributions and management pay are made on a prudent basis.
Speaking during a 17 May board meeting, however, the IASB’s staff recommended against adopting asymmetric prudence.
They warned it could lead to greater subjectivity in financial reporting.
The call also noted that dividend distributions and executive remuneration were issues for local law and corporate governance, respectively.
IASB project manager Jelena Voilo said: “While [the accounts] can be used as inputs for this process, it is not the [purpose] of financial reporting to determine the amounts that can be used without further analysis.”
The Local Authority Pension Fund Forum, as well as Iain Richards of Threadneedle Investments and Roger Collinge of the UK Shareholders Organisation, have all demanded a return to prudent accounting.
On the other hand, IASB member Stephen Cooper, a former sell-side analyst, has argued that prudence would reintroduce a conservative bias that could mean investors receive less relevant information.
The IASB’s predecessor, the IASC Board, approved the IFRS conceptual framework in April 1989.
The IASB subsequently adopted the framework in April 2001.
In September 2010, the IASB revised the framework, in particular the objective of general-purpose financial reporting and the qualitative characteristics of useful information.
The board is now in the process of updating the framework.
The project was originally scheduled to end in June 2015.
It is now slated to terminate around the end of the year.
The decision to remove prudence was driven largely by the rush to converge IFRS with the position in the US.
As part of this convergence drive, the IASB debated the detail of removing prudence from the framework in May 2005.
Staff noted at the time that the concept conflicted with neutrality in financial reporting.
Both staff and the board agreed that “the inclusion of neutrality [was] a non-issue”.
They also noted that it clashed with the accounting traditions of prudence and conservatism.
The decision to revisit the term has left the board struggling to incorporate prudence back into the framework alongside neutrality.
Tim Bush, a long-standing IFRS critic and the head of financial analysis at PIRC, told IPE: “The IASB is so good at missing the obvious it’s like a pantomime where the children are screaming ‘it’s behind you’.
“Prudence is booking likely liabilities and losses, and not booking unrealised profits. Any other definition is harmful to creditors, or else creditors may be funding distributions and losses.
“Furthermore, given that true and fair view requires prudence, the IASB position is confirming IFRS standards are not prudent and does not have a true and fair view override.”
The board’s staff agreed during the 17 May meeting that they would bring back a proposed wording to a future meeting in a bid to clarify the relationship between neutrality and prudence.