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1 CRITIQUE FASB'S CONCEPT STATEMENTS Scott Scott NCU ACC 7035v3 10/31/2023

2 CRITIQUE FASB'S CONCEPT STATEMENTS Analysis and Evaluation of the FASB Conceptual Framework The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) have been working jointly to improve and converge their conceptual frameworks since 2002 (Pelger, 2020). The goal was to create a comprehensive set of concepts and standards that clearly articulate the objectives and principles underlying financial reporting. This convergence effort aimed to improve financial reporting by eliminating alternatives and inconsistencies between U.S. GAAP and IFRS, providing a foundation for setting new standards, and assisting preparers, auditors, and users in resolving accounting issues not directly addressed by the standards (Pelger, 2020). The boards identified two phases of the conceptual framework project - Phase A focused on the objective and qualitative characteristics of financial reporting, while Phase B addressed the reporting entity concept, measurement, presentation and disclosure. In 2010, the IASB completed its conceptual framework project. The FASB continued to work towards completing components of its framework, including issuing updated concept statements on the reporting entity, qualitative characteristics, presentation, and disclosure (Johnson, 2020). The joint initiative has increased international comparability and improved financial reporting, though some differences remain between the two frameworks. The FASB conceptual framework states that the primary objective of financial reporting is to provide sound financial information to existing and potential investors, creditors, and other capital market participants for their decision-making activities like resource allocation and corporate governance (Gjoni-Karameta et al., 2021). The qualitative characteristics refer to the attributes that make financial information useful for

3 CRITIQUE FASB'S CONCEPT STATEMENTS this purpose. Understandability means the information should be readily comprehensible to users with reasonable knowledge of business and economic activities (Gjoni-Karameta et al., 2021). Relevance means the information can make a difference in user decision- making by having predictive or confirmatory value. Materiality is the threshold at which information becomes relevant. Reliability encompasses representational faithfulness (accurate depiction), verifiability and neutrality. Comparability enables users to identify similarities and differences between two sets of economic events. Consistency refers to the use of the same accounting methods over time (Gjoni-Karameta et al., 2021). The tradeoff between relevance and reliability is vital. Information with greater relevance may have to sacrifice some reliability. However, information must have a minimum level of reliability to be useful at all. The framework also discusses enhancing characteristics like timeliness, balance and clarity. The FASB framework outlines four main measurement attributes for financial accounting: a. Historical cost - Assets are recorded at the cash amount paid to acquire them. For example, equipment purchased for $10,000 is recorded at an acquisition cost of $10,000 on the balance sheet until it is disposed of or impaired. b. Current cost - Assets are recorded at the cash amount that would be paid to acquire them presently (Pelger, 2020). For example, equipment with a historical cost of $10,000 may be remeasured at year-end current cost of $12,000, reflecting price changes.

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4 CRITIQUE FASB'S CONCEPT STATEMENTS c. Current market value - Assets are recorded at their exchange value in the open market. For example, marketable securities bought at $10,000 will be reported at their current market value, which may fluctuate. d. Present (or discounted) value of future cash flows - Assets are recorded at the present value of anticipated future cash inflows they are expected to generate (Pelger, 2020). For example, a note receivable of $12,000 due in 2 years may be valued at less than $12,000 today based on the time value of money concepts. The FASB conceptual framework establishes two fundamental recognition criteria that must be met to warrant including an accounting item in the financial statements - definitions and measurability (Johnson, 2020). An item must meet the definition of one of the elements of financial statements - assets, liabilities, equity, revenues, expenses, gains and losses. While seemingly straightforward, this criterion does require extensive judgment and complex analysis in some cases to determine if an item qualifies. For example, determining if research and development expenditures meet the definition of an asset. The item must also be measurable, meaning it has a relevant attribute that can be quantified in monetary units with sufficient reliability. Certain items may clearly meet the definition of an asset or liability but lack reliable measurement attributes. For example, internally generated brands, trademarks and similar intangible assets are not recognized under current standards due to inadequate measurement bases. Criticisms of these recognition criteria include that they are too restrictive and limit the information provided in financial statements. Some argue more items that meet the definitions should be recognized, even if based on less precise estimates or fair values (Kim, 2021). However,

5 CRITIQUE FASB'S CONCEPT STATEMENTS others counter that expanding recognition too far could impair reliability. Overall, the recognition criteria seem logically sound, but room exists to reevaluate specific items that may warrant recognition. The FASB conceptual framework discusses the role of cash flow projections and present value in measuring assets and liabilities. It states that present value techniques are often the best method for capturing the economic substance of assets and liabilities. However, it stops short of requiring or preferring present value measures. The framework cites uncertainty, lack of needed data, and high costs vs. benefits as impediments to requiring present-value techniques. It claims historical cost may provide justifiable approximations of current values in some situations. However, it acknowledges financial statements would be more relevant if present values were used instead of historical costs in more circumstances (Ball & Nikolaev, 2020). Criticisms include that the framework is too hesitant in requiring present value accounting. Commentators argue conceptual merits should take priority over practical difficulties in measurement (Kim, 2021). They claim present values should be mandated for a wide range of assets and liabilities where future cash flows can be reasonably estimated. Reliance on inferior historical cost measures diminishes the relevance and usefulness of financial statements. However, others counter that present value techniques involve significant subjectivity that may reduce reliability. Overall, the framework takes a cautious stance on expanding the use of cash flow projections and present values. A stronger position advocating present value measures where reliable estimates are feasible may improve financial reporting. But practical measurement concerns must be weighed.

6 CRITIQUE FASB'S CONCEPT STATEMENTS The conceptual framework discusses the role and limitations of note disclosures as a crucial part of financial statements. Notes can provide additional details related to items recognized on the face of statements and information about unrecognized items. Common examples include details on accounting policies, business risks, contractual obligations, segment data, post-balance sheet events, pension plans, leases, income taxes and fair values. However, the framework states notes have inherent limitations. Disclosure objectives must be balanced against having too much immaterial information. Preparers may lack incentives to provide full transparency. Auditability also constrains note content. Only certain types of information are verifiable. Preparers may be reluctant to disclose forward-looking information due to litigation fears. Lastly, behavioral research suggests disclosure overload can impair investor analysis. Overall, notes provide critical insights but are limited in the types of information that can reasonably be communicated. The conceptual framework lacks guidance on optimal note disclosure design. Research on effective disclosure formatting and communication is needed. Integrating technology solutions to allow customized note presentations may also improve understandability for different users. In conclusion, the FASB conceptual framework provides a robust foundation for U.S. accounting standards, even though it remains a work in progress. The joint convergence project with the IASB significantly advanced the framework. Key strengths include its articulation of the objectives and qualitative characteristics of useful financial information. The recognition and measurement concepts also establish sound fundamentals, though debate exists in certain areas. Weaknesses pertain to the lack of a completed element definitions phase. Additionally, the framework offers minimal

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7 CRITIQUE FASB'S CONCEPT STATEMENTS guidance on disclosure principles. To improve completeness, FASB should expedite the finalization of its element’s definitions and conceptual reporting model. Additional concept statements on disclosures would also be beneficial. The framework could be expanded to incorporate more guidance on applying materiality judgments and recommendations for pre- and post-implementation review processes when new standards are issued. Formal procedures to continuously update the framework may help maintain its relevance. Overall, the FASB conceptual framework lays a strong foundation, but opportunities exist for enhancement. Ongoing evaluation and timely evolution of concepts will be vital to meeting the objective of providing useful financial information in today's dynamic environment.

8 CRITIQUE FASB'S CONCEPT STATEMENTS References Ball, R., & Nikolaev, V. V. (2020). FASB was right: Earnings beat cash flows when predicting future cash flows. Chicago Booth Research Paper , (20-23). Gjoni-Karameta, A., Fejzaj, E., Mlouk, A., & Sila, K. (2021). Qualitative Characteristics of Financial Reporting: An Evaluation According to the Albanian Users ‟ Perception. Academic Journal of Interdisciplinary Studies , 10 (6), 35-47. Johnson, G. F. (2020). How Meaningful Is the Latest Addition to the FASB Conceptual Framework?. Journal of Accounting and Finance , 20 (5), 155-163. Kim, T. (2021). Conceptual framework for financial reporting: Problems and prospects. Корпоративные финансы , 15 (1), 37-47. Pelger, C. (2020). The return of stewardship, reliability and prudence–a commentary on the IASB’s new conceptual framework. Accounting in Europe , 17 (1), 33-51.