Introduction
The IASB publishes its revised conceptual framework on an annual basis which includes notable changes to the chapters on the objective of financial reporting and the qualitative part of the framework. International Accounting Standards Board (IASB) have had to face a great deal of hardship, in efforts of manufacturing a combined conceptual framework between the IASB and FASB, deeming or seeing the concepts of stewardship and prudence as a necessity in the framework. This paper will critically evaluate the many developments the IASB have had to deal with, in regards to the conceptual framework from the perspective of stewardship and prudence.
What is stewardship?
An Oxford dictionary definition of stewardship is ‘the act of taking care of or managing something, for example property, an organization, money or valuable objects’. If we were to compare this to the definition provided in an academic piece of literature called ‘Conceptual frameworks of accounting from an information perspective’. It states ‘stewardship is the characteristic of accounting information that provides incentives for management to act in the desired way.’ Surprisingly, both definitions have contradictory meanings, which entails an element of a form of underlying ambiguity. This is because of two differing views creating a plethora of discussion and as to what should be the approach of stewardship in regards to the framework.
Since 2006, The debate that is widespread is about whether or not stewardship should be a second objective of financial reporting. The major issue is that there are two schools of thought, with different groups of people who have different needs, depending on a range of factors. What this has meant is that throughout the years, the IASB has had to increase the distinction of the concept, stewardship, in the conceptual framework.
Different views on Stewardship
Geoffrey Whittingham describes the concept as ‘two competing world views.’ He goes on to say in the literature ‘a Fair Value View, implicit in the IASB’s public pronouncements, and an Alternative View implicit in publicly expressed criticisms of the IASB’s pronouncements.’ Fair value essentially has a bias towards what the IASB deems to be a correct conceptual framework, on the other hand an alternative view is often critical and sceptical as to the decisions that the IASB have made. ‘The Fair Value View assumes that markets are relatively perfect and complete and that, in such a setting, financial reports should meet the needs of passive investors and creditors by reporting fair values derived from current market prices.’ This goes on to describe the concepts in more depth, but follows the approach that everything with this, we can derive as to why there are different definitions that differ in statement. The basic definition describes a steward as someone who is ‘taking care of’, on the other hand the Christensen definition has a more critical approach, slamming stewardship as a characteristic which provides incentive for management to act in a desired way. The Stewardship theory heavily links in with Agency theory, which is ‘a group of concepts concerned with resolving the problems caused by the separation of ownership and control, between the principles who are shareholders and agents who are against the directors.’ In an essence, Stewardship (responsibility) theory is a part of a much bigger theory, in which responsibility is handed down from a principle/shareholder to an agent. However, there is no real bias within agency theory, which suggests it is on a more factual basis, in contrast to stewardship which has a spectrum of classifications, depending on the author and piece of literature.
Stewardship and the Conceptual framework
We had identified earlier that people have different thoughts regarding the matter, but the main question still stands, ‘should stewardship be a second objective for financial reporting’? In the 2007 discussion paper from the IASB, they affirm that they don’t see stewardship as an objective on its own and chooses a decision useful objective. The objective of general purpose external financial reporting is to provide information that is useful to present and potential investors and creditors and others in making investment, credit and similar resource allocation decisions.’ This viewpoint is quite consistent amongst individuals who think it could be adverse to include it as it is ‘impossible two have 2 different financial reporting systems.’ As the information provided for decision making purposes and stewardship purposes are not aligned . This is because it is impossible to stop users from using the information provided for decision usefulness for stewardship purposes. What this could entail is that there’s a ‘bias in the accruals which is related to the stewardship use of the information.’ However, others believe that the IASB’s approach to this negatively. In the discussion paper (2007), where the IASB declared their final thoughts and reasoning behind their decisions, received a lot of criticism. This is because the IASB attempted to make all parties of the conflict satisfied by merging opposing ideas of the how the framework should be. ‘If you attempt to merge two different conceptual frameworks, you do not end up with a better framework. You end up with a logical mess.’ He goes on to explain that ‘accounting standards are highly political’, and ‘the design of the conceptual framework will exert a significant influence over when and how accounting issues are settled’, emphasising on the idea that decisions, even small ones, can have severe consequences that may be irreversible. The alternative view values stewardship highly, believing it should be included in the conceptual framework. However, the IASB see it differently. “Financial reporting provides information about an entity during a period when it was under the direction of a particular management, but it does not directly provide information about that management’ performance. To make stewardship a separate objective might exaggerate what is feasible for financial reporting to accomplish.” However, this statement is flawed according to Martin Walker. He explains that the reason as to why Stewardship was not included in the framework could also be applied to decision usefulness, as accounting information can never provide all the information that is relevant for valuing a firm. What the IASB have been doing is improving the distinction of the concept every year.
Agency theory
A steward will always try to create a sense of value for their business. They doing so by being economically astute, ensuring the business is making profits along with positive shareholder pay-outs to optimise shareholder wealth and utility. Agency Theory holds that each individual will work rationally to maximize their utility function, which will ultimately lead to the maximization of personal income by minimizing expenditures. There are differences in agency theory and stewardship theory, but that doesn’t mean there aren’t similarities. Just because agency theory adopts the notion that managers are self-interested and only care about ensuring they receive maximum economic and social benefits, that Stewardship denies this does not happen. Individuals act in an opportunistic way and are self-interested. Both writers agree that individuals only care about themselves. On the other hand, an alternative view of fair value and the conceptual framework shows us how much value Stewardship has to a business. It goes on to say that with a difference in individualistic utility functions between the principal and the manager, conflict could arise. Whittington’s thoughts are ‘that the economic concept of man is limited and simplistic, and entails a broader conception of the Model of Man. A new model of man is needed that is more humanistic and complex and not limited to maximizing a value equation.’ He describes that a new concept should be performed to take into consideration the more human aspects of business. With that being said, it doesn’t seem likely as models and concepts were designed to be basic for the intended user. ‘Stewardship, defined as accountability to present shareholders, is a distinct objective, ranking equally with decision usefulness.’
Advantages and disadvantages
● The info gathered from stewardship information enables certain stakeholders to benefit. ‘Another group of investors look for stewardship information to induce efficient operation of the firm. There is not a generally best accounting system across firms.’ To ensure that investors receive a fair return on their investment, they can take advantage of information provided by stewardship to allow them to identify more ways in which the firm can operate in a more efficient manner.
● A drawback that may incur when adopting stewardship, is that it may present bias information to stakeholders within the business. ‘the general purpose of accounting information is usually cast in the wording of decision information and stewardship information. The bias introduced by the stewardship use of accounting information will always remain.’This is adverse for the constituents of the business as it won’t allow adequate decision making, meaning that the business could be affected negatively. As the shareholders are the principles, it is vital that the correct stewardship information is presented to them.
● What can be established from Christensens readings is that ‘the main content in financial statements is financial information about the firm.’ He goes on to say ‘it was concluded that the optimal information system, which balances cost and benefits of the information system, is highly specific to the details of the specific reporting situation. This includes the decision problems faced, the information present, and the distribution of this information among involved parties.’ Christensen basically says that there is no set of accounting systems which is the best for business. It is unique to each individual business and must be decided through research, practice and the set of financial data available.
● As different data is received amongst different information systems, it could distort the aims and objectives of the business. ‘It is well established that the rankings of information systems for decision purposes and stewardship purposes are not aligned.’ If information systems aren’t in alignment, it makes it hard to analyse the accounting systems. This means that it could slow down the process and/or misrepresent what needs to be done to the current accounting systems. Christensen goes on to state ‘it is impossible to have two different financial reporting systems – one for stewardship purposes and one for decision purposes. It is impossible for the users to commit to not using the decision-relevant information for stewardship purposes as the use of the information system is decoupled from the production.’
What is prudence and how has it changed in the conceptual framework?
Prudence is defined by the Oxford dictionary as ‘a sensible and careful attitude when you make judgements and decisions; behaviour that avoids unnecessary risks,’ in comparison to a basic accounting definition, ‘Do not overestimate the amount of revenues recognized or underestimate the amount of expenses. You should also be conservative in recording the amount of assets, and not underestimate liabilities.’ This is more isolated to the financial accounts and ensuring you take a cautious approach when valuing assets. This concept is seen as the conventional form of prudence, and has resonated in the accounting world since the beginning of the Conceptual framework in 1989. The IASB view prudence in a positive manner, but try to intertwine the word ‘neutrality’, viewing prudence as an aspect of neutrality. This is because the IASB need to ensure that accounting is ‘neutral’. ‘With the desirable quality of neutrality, which encompasses freedom from bias.’ The main issue that is always highlighted with academics is the consistency of the definition, provided by the IASB. ‘Prudence is not inconsistent with neutrality but can instead be seen as a mechanism for ensuring neutrality, for exercising careful judgement in ensuring that accounting is neutral.’ In today’s world, prudence is struggling to find its place as there is a significant debate as to whether IFRS should include it in the conceptual framework. In the 1989 edition of the Conceptual framework, the IASB were scrutinised for their adaptation of prudence due to its ambiguity. Neutrality was defined as ‘To be reliable, the information contained in financial statements must be neutral, that is, free from bias. Financial statements are not neutral if, by the selection or presentation of information, they influence the making of a decision or judgement in order to achieve a predetermined result or outcome’. (para. 36 of 1989 framework). Moreover, the following paragraph gives us more clarity as to what they expect from neutrality. ‘The preparers of financial statements do, however, have to contend with the uncertainties that inevitably surround many events and circumstances, such as the collectability of doubtful receivables, the probable useful life of plant and equipment and the number of warranty claims that may occur. Such uncertainties are recognised by the disclosure of their nature and extent and by the exercise of prudence in the preparation of the financial statements. Prudence is the inclusion of a degree of caution in the exercise of the judgements needed in making the estimates required under conditions of uncertainty, such that assets or income are not overstated and liabilities or expenses are not understated. However, the exercise of prudence does not allow, for example, the creation of hidden reserves or excessive provisions, the deliberate understatement of assets or income, or the deliberate overstatement of liabilities or expenses, because the financial statements would not be neutral and, therefore, not have the quality of reliability (para. 37 1989 framework). The inconsistency does not lie within the first half of paragraph 37, which states that assets or income must be understated, and expenses and liabilities must be overstated, but the ‘deferred recognition of uncertain gains.’ The ambiguity of the text makes it irreparable as prudence has different thought bases.
The issue really ignited during, and after, the financial crisis. Prudence was included in the conceptual framework at the time, and many criticisms of the IFRS was that “a lack of prudence in the IFRS help create the over-exuberance of expansion, unrealised profits, unjustified bonuses and dividends?” (ACCAglobal 2014). In 2010, the IASB decided to wipe the concept out entirely from the framework, due to the misconstrued interpretations. It was decided in 2015 that it should be reintroduced, but only in the IASB version of it. ‘the exercise of prudence is consistent with neutrality and should not allow the overstatement or understatement of assets, liabilities, income or expenses.’ (framework 2015). This also received scrutiny from academics and users, as it was ‘fundamentally flawed.’ It was considered pointless and confusing adding a ‘concept’ that does not really add anything on to the neutrality concept, as it is very broad. ‘At best this achieves nothing; at worst it leads to confusion.’
Conclusion
Too conclude, we realised that both concepts have ambiguity and different schools of thought which means that users, with individual needs and wants, will be affected differently thus users will formulate different opinions on the matter, whether or not the concept has been removed or added in to the conceptual framework.