An Analysis of Concepts and Evidence on the Question of Whether IFRS Should be Conservative

Abstract

Do international accounting standards require conservative accounting? The IASB's conceptual framework suggests that they should not, while the research literature is largely silent on the matter, typically presuming conservatism to be an outcome of private contracting rather than standardized, public, general purpose financial reporting. In this paper, we analyze the actual requirements of IFRS. We find multiple examples of recognition requirements that lead to unconditional conservatism, measurement requirements that lead to conditional conservatism, and also presentation/ disclosure requirements that further support a conservative reporting environment. These findings complement, support and deepen existing evidence in the empirical literature that accounting is in practice conservative. We show, however, that the requirements for conservatism in IFRS conflict with, first, the IASB's stated position in its conceptual framework that accounting should not be conservative and, second, the private contracting explanation for conservatism that is generally accepted in the literature. What is missing, and lies behind both conflicts, is an acknowledgement and understanding of the role of an agency/contracting perspective in enhancing the decision-usefulness of general purpose accounting standards, given the information/incentive asymmetry and uncertainty that characterizes the real-world context in which those standards operate. From a policy perspective, such an understanding would reconcile the IASB's conceptual framework with the actual requirements of IFRS. From a research literature perspective, such an understanding would re-position accounting standards as central to the practice of accounting conservatism, which would in turn require revision to the generally accepted theory of a private contracting explanation for the empirical evidence of conservative accounting practice.

Conservatism in residual income models: theory and supporting evidence

“…Hence the two manifest themselves in the statements of the financial positon in the same way, with reported book values lagging prices. This view that conservatism is essentially a timing issue is also echoed in the recent P D Leake ICAEW Lecture (Barker 2014) in which he argues that such a definition is general and no distinction is made between the different sources of conservatism.…”

Accounting Research in Abacus, A&F, AAR, and AJM from 2008–2015: A Review and Research Agenda

“…Future research can contribute to the ongoing monitoring of the effects of international accounting standards, including studies on important fundamentals of accounting. Researchers interested in this field can build on existing studies of value relevance (Chalmers et al ., ; Clacher et al ., ; Martinez et al ., ); disclosure (Stent et al ., ; Wee et al ., ); earnings management (Navarro‐Garcia and Madrid‐Guijarro, ); private equity valuation (Palea and Maino, ); conservatism (Barker and McGeachin, ); firm financing behaviour (Tarca et al ., ); and earnings forecasts (Chalmers et al ., ; Cotter et al ., ). There have also been studies investigating specific standards (e.g., IAS 19 Defined Benefits (Cho et al ., ) and IFRS 8 Segment Reporting (Kang and Gray, )).…”

Conservatism, prudence and the IASB's conceptual framework

“…These definitions have in common an emphasis on verifiability and, in that respect, on asymmetry between gains and losses (Barker and McGeachin 2013). There is, in the literature, considerable empirical evidence that these definitions are consistent with conservatism in accounting practice (Watts 2003b, Kothari et al 2010, Shivakumar 2013, Mora and Walker 2014, and also that they are also consistent with the actual requirements of IFRS (Barker and McGeachin 2015). 1 The policy implications of this academic perspective seem to be largely shared with the practitioner community, which has for the most part been critical of the position taken by the IASB.…”