Adding colour to the numbers: the IASB's Conceptual Framework
The IASB’s current exposure draft of proposed amendments to the Conceptual Framework for the IFRS has some interesting nuggets that are relevant to valuation. Indeed, the framework is recommended reading for any valuer preparing valuations for use in financial statements, as it clearly sets out the reasons why valuation measurements are required and the context in which they are useful.
While slightly tangential to the theme of valuation, it is interesting to observe the debate the IASB has been having over some basic definitions within the existing framework. One that seems to have generated particular controversy is the proposal to delete references to cash inflows or outflows being “expected” in the definitions of assets and liabilities. The reasons for this include concern at the tendency for some to place an arbitrary, quantifiable probability on what is meant by “expected” in order to determine whether an asset or liability should be recognised, which is not the intention.
This debate is symptomatic of a common challenge for standard setters. Too often users of the standards seek to over interpret and explore the extremes of meaning that can be applied to words and phrases that are simply intended to mean no more or less than they do in everyday common usage. To quote the golfer, Gary Player, this can lead to paralysis by analysis. In any professional activity involving skill and judgement, qualitative adjectives such as “expected”, “reasonable”, “anticipated”, “possible” etc have to be used in drafting standards or guidance as the right course to take still remains the responsibility of the professional after they have weighed all the facts and circumstances relevant to the problem being addressed. Unfortunately a significant minority seem want to replace skill and judgement with hard wired solutions, thinking that the solution can be computed by linking a series of defined quantitative metrics. However, this is no more likely to produce a desirable outcome than a painting produced by joining the dots in a colouring book is to be mistaken for the work of a grand master.
Producing conceptual frameworks is one way in which the standard setter can help users focus on the overriding objectives of the standards. They add colour which can assist consistent interpretation of the more detailed provisions in individual standards. The proposed IFRS Conceptual Framework includes useful guidance on the accounting objectives underlying the individual IFRSs and helps the reader understand why valuations can provide useful information in financial reporting. By nature valuers are often specialists in a particular type of asset or liability and may also be very knowledgeable about the accounting requirements for that asset. However, the Conceptual Framework looks at the bigger picture and places the valuation task into an overall context.
Some examples of discussions that should be of relevance to valuers include:
The discussion on determining the “unit of account” in 4.53 – 4.67 of the draft is a useful extension of the discussion on “aggregation” in paras 23 -24 of the IVS Framework, and could be helpful as the basis of a discussion between valuer and client about the scope of any valuation intended for financial reporting.
It is recognised that some measurements have to be estimated and that some estimates may be subject to uncertainty. However, 5.20 of the draft makes it clear this does not necessarily undermine their usefulness providing suitable disclosures are made. This is of course a common requirement in valuation standards.
Chapter 6 on measurement provides an interesting overview of the pros and cons of historical cost and current value, and where a choice is permitted in the relevant IFRS, matters that could indicate which is the most appropriate. While valuers sometimes have a natural bias towards thinking valuation is always the more relevant measure, this discussion shows this is not always the case. It also makes the point that historic cost is itself just as open to subjectivity as current value because of the judgement necessary when making depreciation or impairment adjustments.
In my experience the focus of debate about valuation is all too often on the “how” rather than “why”. This is sometimes an inevitable consequence of specialists focussing on their specialism but the usefulness of any professional advice, including valuation, is enhanced if is provided with appreciation of the context in which it is to be used.
The IASB is inviting comments on the Exposure Draft before 26 October. Valuers active in the financial reporting arena would do well to study the draft and let the IASB know whether they find the proposed Conceptual Framework helpful, or if there is anything else that could be addressed in order to further clarify the role and purpose of valuation measurements.