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UK FRC blasts IASB 'wholly inadequate' prudent accounting standards

The UK accountancy and audit watchdog, the Financial Reporting Council (FRC), has slammed the International Accounting Standards Board’s (IASB) position on prudent accounting as “wholly inadequate.”

Long-standing critics of the UK’s accounting establishment have, however, dismissed this latest salvo in the war of words over the standard setter’s conceptual framework project as mere semantics.

In a hard-hitting attack, Melanie McLaren, the FRC’s executive director with responsibility for codes and standards, said: “We have consistently made clear to the IASB that stewardship, prudence and reliability are fundamental to financial reporting.

“Although the Exposure Draft goes further than the IASB has previously in recognising their importance, significant further development is essential if we are to be confident that future IFRSs are to be of high quality.”

McLaren continued: “Investors rely on financial reporting to hold management to account – to assess the delivery of the business model and the creation of long-term shareholder value.

“By describing prudence merely as taking a cautious approach to accounting, the IASB has missed the point – prudence requires a greater readiness to recognise losses than profits.”

She said it was “particularly odd” the IASB acknowledged that this was reflected in current accounting standards yet omitted it from its draft Framework.

The IASB launched its project to update and finalise its conceptual framework – the building blocks of its standard-setting activities – in 2011.

Since then, it has issued a discussion paper and, more recently, an exposure draft.

The framework defines the objective of general purpose financial reporting and details the two fundamental qualitative characteristics of useful financial information – relevance and faithful representation.

Sitting below these characteristics are four so-called enhancing qualitative characteristics – comparability, verifiability, timeliness and understandability.

The notion of prudence was originally in the 1989 iteration of the framework. The board removed it in 2010 but now proposes to reintroduce due to pressure from some investors.

In the UK, an investor coalition that includes the Local Authority Pension Fund Forum, Threadneedle Investments and the UK Shareholders’ Organisation, has demanded that the IASB bring back prudence as an overriding accounting principle.

The investor group recently wrote: “Prudence should be restored as the overriding accounting principle so that capital and performance are not overstated. The breakdown of realised and unrealised income should be visible to all.

“They [IASB] are developing standards that suit the profession, but they are not setting standards with any consideration as to how they might be audited.

“These changes are not just vital for effective stewardship by executives, directors and shareholders – they are necessary to bring the accounting framework back into line with existing legal requirements for capital protection as originally set out in the EU’s second directive.”

The IASB tentatively voted to remove prudence from the framework during a May 2005 board meeting when it seemed likely the US would adopt IFRS as the reporting basis for public companies.

A staff meeting paper from that meeting read: “Reliability is said, in FASB Concepts Statement 2, to comprise representational faithfulness, verifiability and neutrality, with an overlay of completeness, freedom from bias, precision and uncertainty.

“It is said in the IASB Framework to comprise faithful representation, substance over form, neutrality, prudence and completeness.”

The staff added that, although “the inclusion of neutrality [was] a non-issue”, it clashed with the accounting traditions of prudence and conservatism.

Meanwhile, a decade on, the FRC now wants the IASB to make an explicit reference to “asymmetric prudence” – or a lower threshold for the recognition of liabilities and losses than for assets and gains – in the main framework text.

The FRC said: “The effect of these changes is significant. In the 1989 text, the avoidance of understatement of assets, etc, was a check on the exercise of prudence—which naturally we would support.

“But, in the text proposed in the Exposure Draft, it is placed as part of prudence itself. The result is that the idea of prudence loses any sense of direction and is indistinguishable from the idea of neutrality.

“However, it is perverse to accept that a concept plays a role in accounting standards while omitting a discussion of it from the Conceptual Framework.

“To do so is to accept that the Conceptual Framework is incomplete and that the IASB will have recourse to undefined and unspecified ideas in the future development of accounting standards.”

This latest hard line from the FRC has left some IASB critics unconvinced.

Leading UK accounting academic professor Stella Fearnley told IPE: “We don’t need statements or mantras about neutrality or bias.

“A simple definition of prudence is all that is required so that assets are not overstated and liabilities are not understated.

“Equally, profits should not be booked until they are realised, and losses should be booked as soon as they are expected.

“From a public policy perspective, you have to ask why has it taken the FRC as long as it has to even get this far. We have the second-largest capital market in the world, and yet we seem unable to address this issue.”

LAPFF chairman councillor Kieran Quinn added: “The Opinion of George Bompas QC is clear and covers the specific purpose of accounts, for which the correct model of prudence is the appropriate method to get the numbers right.

“The standard setters are failing. Until the standard setters get the purpose right, they force an unnecessary debate about different version of ‘prudence’ when we believe there is clarity.”

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