Moving the Conceptual Framework
Forward:
Accoun9ng for Uncertainty
RichardBarker
SaïdBusinessSchool,OxfordUniversity
and
StephenPenman
ColumbiaBusinessSchool,ColumbiaUniversity
The Conceptual Framework of the IASB: Outline
(condensed)
Objec=ves
“…provideusefulfinancialinforma=on…toinvestors…abouttheamount,=ming,anduncertaintyof
futurecashflows”(emphasisadded)
“...andassessmentofmanagement’sstewardship…”
↓
Qualita=veCharacteris=cs
↓
Recogni=onandMeasurement
Recogni9on and Measurement is Where the Rubber
Hits the Road
TheSolu=onintheCF(aso-calledBalance-SheetApproach):
•  Recogni=on
---sa=sfystateddefini=onsofassetsandliabili=es
---subjecttoQualita=veCharacteris=cs
Incomeisjustaby-product,fallingoutfrombalancesheet
recogni=on
•  Measurement
---Twochoices:historicalcostandcurrentvalue
---LiTleguidanceaboutmakingthechoiceapartfromqualita=vecharacteris=cs
The Alterna9ve Income-Statement Approach
•  Recogni=on:
---recognizerevenueunderarevenuerecogni=onprinciple
---matchexpensesagainstrevenuetocalculatenetincome
Thebalancesheetisjustaby-productofmatchingintheincome
statement
•  Measurement:
---valuecanbeassessedfrom(capitalized)flowsratherthanstocks,anditishard
foranaccountanttocommunicatevaluethroughstocks
---sa=sfiesstewardshipobjec=ves:Hasmanagementaddedvalue?
Our Cri9que
1.  Agreewiththeobjec=ves
2.  Qualita=veCharacteris=csdonothavethecu\ngedgetoresolve
Recogni=onandMeasurement
3.  Thebalance-sheetapproachisnotsufficienttoresolvetheissues:
theincomestatementisalsotobeconsidered
4.  Anincome-statementapproachalsodoesnotresolvetheissues
5.  However,abalance-sheetapproachisthestar=ngpointtoyielda
mixedbalance-sheetandincome-statementapproachthatdoes
resolvetheissues
The CuLng-Edge Idea: Accoun9ng for Uncertainty
•  Uncertaintyispervasiveininves=ngandtheCFObjec=vesrecognize
it.ButitgetsliTlefocusintheCF
•  Thereisnoaccrualaccoun=ngundercertainty:Itisuncertaintythat
givesaccoun=ngthepoten=altobeinforma=ve
•  Accordingly,accrualaccoun=nghasthepoten=altoconvey
informa=onaboutuncertainty(aswellasexpectedcashflows)
•  Acombinedbalance-sheetandincomestatementapproachcoveys
informa=onaboutuncertainty
AnAccoun=ng101Story
Recogni9on
The Balance-Sheet Approach under Uncertainty
(Assets)
Thestatedcriteria:expectedfutureeconomicbenefits(plusothercriteria)
BUT….
Expecta=onshavevaria=onaroundthem,theyareuncertain
•  Areallassetswithexpectedbenefitstoberecognizedonthebalancesheet
---allR&Dirrespec=veoftheprobabilityofanoutcome?
•  Theconsequences
---theincomestatementisswampedbywrite-downs:mismatchingdestroystheincome
statement
---”waterinthebalancesheet”
Somethingismissing:athresholdforadmi5nguncertainty
The Income Statement Approach under Uncertainty
•  Perfectmatchingisonlypossibleundercertainty
•  Uncertaintyimpliesmismatching
•  Mismatchingdestroystheincomestatement
Somethingismissing:anaccoun6ngthatpreservesmatchingunder
uncertainty
The Solu9on
•  Implementthebalance-sheetapproachforrecogni=onbyadmi\nga
thresholdforuncertainty
•  Establishthatthresholdbasedontheconsequencesformatchingin
theincomestatement
The Balance-Sheet Approach Par9ally Recognizes a
Threshold: Revenue Recogni9on via the Balance Sheet
•  Revenuerecogni=onviatheincomestatement:arealiza=onprinciple
---recognizerevenue(andthecorrespondingasset)onlyaferuncertaintyhaslargely
beenresolved
•  Revenuerecogni=onviathebalancesheet:anassetrecogni=onprinciple
---recognizeanasset(andthecorrespondingrevenue)if“controlledbytheen=tyasa
resultofpastevents”(emphasisadded)
Thisrulesoutan6cipated,uncertainfutureevents
IRFS15canbeseenasabalance-sheetapproachtorevenuerecogni=on
The Founda9on for Accoun9ng for Uncertainty is Already in the
CF
But, the Balance-Sheet Approach is Not Complete
•  IntheCF,incomestatementrecogni=on(forrevenues)issolvedviaa
balance-sheetapproach
•  Accordingly,thebalance-sheetapproachyieldsdefini=onforboththe
balancesheetandtheincomestatement
•  TheCFrulesoutafull“fairvalue”balancesheet
•  Theaccoun=ngconveysinforma=onaboutuncertainty:theP/Sra=o
•  However,itisonlypar=aldefini=on(anddoesnotgettotheP/Era=o):
---nothresholdforrecognizingassetsinthebalancesheetthatproducerevenue
---nodefini=onofexpensesintheincomestatement
The Solu9on: Matching under Uncertainty
Thebalance-sheetthresholdisestablishedwithregardtothe
consequencesformatchingintheincomestatement
ThePrinciple:
Assets(asdefinedintheFramework)shouldnotberecognisedunless
eitheranevidence-basedamor=za=onschemecanbeestablishedex
ante,orelserealiza=onuncertaintyislow,suchthattheconsequent
mismatchingisunlikelytoaffecttheincomestatementsignificantly
Specificity is Golden:
Four Types of Matching
Type1.Revenuematching:expensesthatdirectlyconnecttorevenue
Think:inventoriesandcostofgoodsold
Type2.Exanteperiodmatching(evidence-basedexante)
Think:PP&E,leases,definite-livedintangibles
Type3.Expostperiodmatching(evidencebasedexpost)
Think:gainsandlossesonmark-to-marketsecuri=es
Type4.Expensesthatcannotbematched,eitherexanteorexpostdue
touncertainty
Think:basicresearch
The Resul9ng Income Statement
Revenue
100
TheseareType1:revenuesarereportedasearned,
andexpensesarematchedtorevenues
CostofGoodsSold
25
GrossProfit
75
Overheads
UnderlyingProfit
40
35
TheseareType2:expensesarematchedto=meperiods
MismatchedExpenses
ProfitbeforeGainsandLosses
10
25
TheseareType4:resourceoujlowsexpensedinthe
absenceofeitherevidence-basedamor=sa=onor
reasonablecertaintyofrealiza=on
GainsandLosses
5
TheseareType3:gainsandlossesthatarematchedex
postto=meperiods,includingimpairmentlosses
ProfitbeforeInterestandTax
20
FinancingExpenses(Income)
8
(Amounts here represent the separa=on of financing
fromopera=ngac=vi=es)
ProfitbeforeTax
12
Tax
3
Profit/Loss
9
Proper9es: The Income Statement
Providing informa9on about “the amount, 9ming, and uncertainty of future cash flows”
“...and assessment of management’s stewardship…”
•  Types1and2matchingsec=onprovidesinforma=onaboutfutureearningsand
cashflowfromsales---earningstowhichaP/Emul=plecanbeapplied
•  Type3expostmatchingsec=onseparatesincomethatcannotforecastfuture
income…butvalueisinthebalancesheet
•  Type4mismatchingsec=onprovidesinforma=onabouttheuncertaintyof
futurerevenue
Adiagnos=c:Incomefromrevenues/Mismatchedexpensesconveystheextentoftheuncertainty:
Alowra=oindicatesnotmuchincomeisbeingrealizedrela=vetoriskyinvestmenttogainfuture
revenues
•  Forstewardship,alineitemissuppliedtorewardthemanagerontheresolu=on
ofuncertainty,notforintroducinguncertainty.
Proper9es: The Balance Sheet
•  Reportsonlyopera=ngassetsthathavesignificantprobabilityofyieldingcash
flows
Think:inventoryindicatesthefirmcanproducerevenues
vs.
largeresearchexpendituresintheincomestatementindicatelowerprobabilityof
revenuesinthefuture
•  No“waterinthebalancesheet”thatcanevaporatelater
Measurement
Measurement in the Conceptual Framework
Themenu:
1.  Historicalcost
2.  Currentvalue
---exitprice(“fairvalue”)
---value-in-use
Measurement Under Uncertainty
Given Recogni9on solu9ons, Measurement Rolls off the Tongue
ResolvedbyType:
Types1and2:Implieshistoricalcost—tobematchedwithrevenueson
realiza=on.
Resolu=onuncertaintyimpliesnocurrentvalueaccoun=ng.
Giventhebalance-sheetapproachforrevenuescurrentvalueforotherassetsimplies
mismatching.
Type3:Lowresolu=onuncertainty—marketpricesareknown
Butonlyforstand-aloneassets(wherethecontribu=onoftheassettothevalueoftheporjolio
anditsriskisdefined).“Fairvalue”(exitvalue)doesnotsolvetheproblemforjoint-useassets.
Type4:Moot
How Do Investors Use Accoun9ng Informa9on? …. Absent from the CF
Connec9on to Prac9cal Valua9on
TheResidualIncomeModelyieldsanequivalentvalua=ontoexpectedcash
flowsdiscountedforrisk.Theconstantgrowthversion:
Earningstowhich
amul=pliercanbe
appliedforgrowth
↓
( Earnings0 − r.Book Value0 ) × g
Value0 = Book Value0 +
r − g
↑↑
NotdiscountedInforma=onabout
forriskthediscountrate