For our Wednesday, April 15th session (11am ET), Office Hours will focus on the Conceptual Framework Project.  Leading the discussion will be Ron Bossio, Senior Project Manager, and Kevin McBeth, Project Manager, from the Conceptual Framework Project Team.  You can read about the project itself on the FASB’s Conceptual Framework Project Page. Information on getting to office hours is available here.  Some thoughts on the Framework (with heavy emphasis on Joel Demski) below the fold.

Sometimes I think that differences of opinion on the importance of the Conceptual Framework are as wide as differences of opinion on the appropriateness of Fair Value Accounting.  The debate isn’t as loud, though, because those who think Fair Value Accounting is inappropriate argue vehemently against it, while many who think the Conceptual Framework is not important just quietly ignore it.

The most common concern about standard setters is that the framework is just too vague to guide standard setting in any meaningful way.  Larry Smith, FASB Board member, seemed to have sympathy with that view during office hours back in January.    But Sue Bielstein, long-time FASB staffer, also emphasized the role of the standards in guiding the staff’s analyses, and on the IASB side, Mary Barth once told me that when she joined the IASB she signed a document promising to pass standards that uphold the Conceptual Framework.  Overall, my impression is that the Framework does indeed have a fair bit of influence on deliberations.

Which means that it probably is worth arguing over the Framework after all.

One academic who has consistently spoken against the Framework has been Joel Demski.  Joel argued for “The general impossibility of normative accounting standards” (Accounting Review 48(4)) back in 1973, relying on Blackwell’s theorem to conclude that no one structure for information is optimal for all decisions.  He has returned to the topic again in recent years, with his Accounting Horizons article “Anticipatory Reporting Standards” (21(4), December 2007, with John Christensen).  This time, Joel turns his sights particularly on the Framework’s embrace of “neutrality.”

D&C quote from the Framework:

Neutrality does not mean without purpose, nor does it mean that accounting should be without influence on human behavior. Accounting information cannot avoid affecting behavior, nor should it … To be neutral, accounting information must report economic activity as faithfully as possible, without coloring the image it communicates for the purpose of influencing behavior in some particular direction. (FASB 1978, 100)

They then point out that since accounting standards do affect behavior — influencing the transactions that are being accounted for — neutrality is an unattainable goal, and a more appropriate goal would be to anticipate such effects.  I quote from their conclusion in its entirety:

The Conceptual Framework is not inherently anticipatory; it invites an arguably neutral approach of focusing on how transactions are best reported, independent of the motives behind or supply of those transactions. In so doing, it treats accounting issues as a first-order concern, but relegates the supply of transactions to second-order concern. As a result, the essential role of anticipating the reaction to a reporting standard is shorted in the regulatory calculus.

Reporting details are potentially driven by the reporting standard in conjunction with the particular interests of the reporting organization. The reporting organization is likely to be better informed than the rest of the players, and also to have private reporting incentives. This opens a feedback loop which is not easy to control by means of good intentions. The Framework mutes if not blinds the analysis to these reactive effects, and, as a consequence, fosters potentially serious error when used as a platform for instruction or regulation.

To be sure, admitting to reactive effects is easier than effectively dealing with them. We do not expect our regulators to be prescient, and this raises the question of whether a regulatory approach that devotes serious effort to dealing with finer details and estimating reactive effects, though with inevitable error, would perform more or less effectively than the status quo. Stated differently, is the portfolio of regulatory missteps likely to be more or less troubling if (1) the qualitative characteristics approach, with its lack of emphasis on finer details and reactive effects, were followed or (2) a more consequential approach, based on finer details and errors in their assessment, were followed?

This is a debate we are yet to engage. But it is also a debate the Conceptual Framework, in its present form, does not encourage. To be effective, the Framework must, in our view, adopt an equilibrium perspective, one based on anticipation of the effect of the promulgated standards or regulations. The finer details of the reporting problem are important, including the equilibrium supply of transactions.

Once this equilibrium perspective is part of our cognitive fabric, we will be in a position to engage such a debate.for the purpose of influencing behavior in some particular direction. (FASB 1978, 100)

Are standard setters ready for equilibrium analysis?  I am not sure….but it might be possible to persuade them that conservatism, rather than neutrality, has merit.

p.s.  I should point out that D&C also make a broader argument that standards shouldn’t be based on any qualitative characteristics, but instead by the ‘finer details’ of particular settings.  I can see their point, but I don’t see how such a framework would be any different from an entire body of particular standards, and thus would provide no way to guide standard setters.