The AAA’s Financial Accounting Standards Committee recently put together a proposal for an alternative conceptual framework. Conceptual frameworks (CF), by their nature, deal with such fundamental and far-reaching concepts that these types of intellectual ventures are bound to generate disagreement. This proposal is no exception, as evidenced by the dissenting opinions, and is not only quite critical of the current CFs of the FASB and the IASB, but also offers a perspective that is largely antithetical to the philosophies espoused by the FASB and IASB.

As the committee notes in their abstract, it was their intent to be thought-provoking, so I encourage you to read their proposal and form your own thoughts and opinions. What I offer here are a few initial impressions of my own, which I number for ease of subsequent reference.

Point 1) To begin with, the committee’s proposed CF is, by design, constructed on the basis of critiques of what the FASB/IASB have done wrong. While I can see value in a document that critiques the current basis for standard setting, it is not clear to me that future standard setting ought to derive out of an “ought not” perspective. In other words, the document asserts that the primary function of a conceptual framework is to restrict standard setters along important dimensions. But there is little evidence or reasoning offered to support this view. In my opinion, the purpose of a CF is to dig deep roots to ground the thinking and reasoning of future standard setters, and not (primarily) to set up patchwork fences. My basis for taking this perspective is a belief that it is impractical to anticipate today all the points at which we would like to restrict the actions of future standard setters. Far better to provide them with a set of core ideals from which to reason.

Point 2) I also disagree with the assertion that the FASB’s CF has not been very influential. There are many cases where new standards have been issued to change existing accounting practices which, in the process of becoming generally accepted, turn out to be inconsistent with the CF. For example, SFAS 146 comes to mind, which corrected problems raised by EITF 94-3 allowing the recognition of items on the balance sheet that failed to meet the definition of a liability. One could say that EITF 94-3 is evidence that the CF failed. But I would say that EITF 94-3 is evidence that standard setters are imperfect, and SFAS 146 is evidence that a CF can help to bring standard setting back to a set of core ideals in cases where it has deviated. (On this topic, I think Robert Bloomfield’s dissent, which Ted Christensen endorses, is insightful in noting that the FASB’s CF is apparently influential enough to have, ironically, shaped the way that the Committee justified the principles in its own alternative framework.)

Point 3) The Committee asserts that one benefit of the proposed CF is that many “crucial accounting issues have been settled up front.” I disagree and see this as no great advantage of the Committee’s “fences” perspective. It is easy to resolve difficult accounting issues. It is much harder to justify those decisions to constituents when they naturally involve difficult trade offs. This reminds me of a quote from the autobiography of Alan Greenspan, where he says “Sometimes the duty of political leadership is to convince constituencies that they are just plain wrong.” I believe that an effective CF can be immensely helpful in doing just that. Moreover, ignoring difficult trade offs, by refusing to establish useful decision criteria and instead resolving issues by fiat, is not an advancement in thinking, but rather a regression of it.

Point 4) The first principle (“Recognition and measurement rest on interpreting transactions”) makes it sound as if objectivity is paramount. But this is misleading because, in the very next line, a qualifier is slipped in, which clarifies that the transactions to be interpreted are only those “in which the firm is involved.” This, in my mind, is a significant qualifier and reveals that objectivity is not the primary concern. Rather, I believe the Committee’s objective in choosing this principle is to endorse historical cost as the primary measurement attribute in accounting. The problem, as I see it, is that I doubt anyone would disagree with the usefulness of drawing information from transactions, whenever relevant transactions are available for reference. The more subtle point (namely, that only a firm’s own transactions are relevant), is much more controversial and is not one that is addressed in this document. To be convincing, the Committee’s CF needs to more effectively argue why the usefulness of transactions needs to be linked to a firm’s own transactions. For similar reasons, I believe the section ends with an adage that is also misleading. The CF proposed by the Committee does not equally embrace all facts, but rather puts a premium on only those facts with which a firm is directly involved. That stance might be reasonable, but it ought to be clearly taken and, ideally, justified as meeting a clear objective (probably stewardship).

Point 5) The Committee strongly advocates adopting an income statement perspective in their CF. In doing so, they face the same difficulty as all previous supporters of this perspective – namely, how to determine what core earnings is and how it should be measured without making reference to what assets and liabilities are and how they should be measured. It is simple to state that earnings should be primary (with assets and liabilities falling out as a function of accurately measuring earnings), but it is more difficult to articulate why it should be so – especially in the absence of well-specified objectives and decision criteria.

Point 6) The proposed CF asserts that “Accounting should not rest on a principle under which reasonable and honest individuals can disagree materially on what asset and liability values on the balance sheet ought to be,” but this is an impossible objective. Moreover, I do not believe that the Committee has made the case for why standards that require “smoothing to permanent operating income” are likely to lead to less disagreement about how that should be done (or what that even means) than would standards that require fair value measurements (especially, when those fair value measurements are rooted in observable transactions or agreed upon measurement models). This is not say that fair value is the right way to go in all (or even most) situations, but rather to point out that both perspectives are likely to engender reasonable disagreement among thoughtful individuals. This sort of misunderstanding is similar to what I have already commented on in a previously posted article.

One last (minor) comment (Point 7): The proposed CF eschews the FASB’s platitudes, but then issues some of its own, such as the requirement that “earnings provide a useful starting point for the forecasting of future earnings.” If we establish decision usefulness, for the purpose of capital allocation decisions, as the primary characteristic of accounting information (which this CF does not do), then I doubt anyone would disagree with that requirement. But the larger point is that there are many alternative functions of accounting information which would subordinate the usefulness objective to other objectives, such as maintaining macroeconomic financial stability or facilitating stewardship evaluations. (Rob makes a similar point in his dissent.) As such, I do not think the FASB’s CF includes as many “useless” platitudes as is implied by the majority of the Committee.

I hope these comments are useful to the Committee and to others who read the Committee’s proposed CF. I strongly believe that these issues are important and that they warrant careful consideration and open debate. As the FASB/IASB’s joint project moves forward, it is exactly this sort of intellectual dialogue that, in my opinion, offers the greatest hope that the next joint framework will lead to improved standard setting, communication, and education. To that end, I encourage you to voice your opinion by sharing your comments with the Committee and/or me, or (best of all!) by commenting below and sharing them with everyone!


Disclaimer: The views expressed here are my own and do not represent positions of the Financial Accounting Standards Board. Positions of the FASB are arrived at only after extensive due process and deliberations.