Moving the Conceptual Framework Forward: Accounting for Uncertainty

Abstract

To meet the objectives of financial reporting in the IASB's Conceptual Framework, the “balance‐sheet approach” embraced by the Framework is necessary but not sufficient. Critical, but largely overlooked, is the role of uncertainty, which we argue defines the role of accrual accounting as a distinctive source of information for investors when investment outcomes are uncertain. This role is in some sense paradoxical: on the one hand, uncertainty undermines both the balance sheet (because uncertain assets are unrecognized) and the income statement (because mismatching is unavoidable). However, these inevitable accounting effects can be exploited to provide information about uncertainty, though not by a balance‐sheet approach alone. Rather, balance sheet recognition and measurement criteria are established by consideration of the impact of uncertainty on matching and mismatching in the income statement. This combination of balance‐sheet and income‐statement approaches enhances the communication of information to investors under conditions of uncertainty, thereby giving greater clarity and purpose in satisfying the objective of the Framework to provide information about “the amount, timing, and uncertainty of future cash flows.”

Articulation, Profit or Loss and OCI in the IASB Conceptual Framework: Different Shades of Clean (or Dirty) Surplus

“…See also Barker (2010b). Barker and Penman (2016) argue that the 2015 IASB CF ED does not sufficiently incorporate the concept of uncertainty in its approach to the determination of financial performance. Barker and Penman (2016) also represents a mixed balance sheet and income statement approach to the determination of financial performance, whereby the all-inclusive concept of financial performance and the clean-surplus concept of equity are maintained.…”

“…Barker and Penman (2016) argue that the 2015 IASB CF ED does not sufficiently incorporate the concept of uncertainty in its approach to the determination of financial performance. Barker and Penman (2016) also represents a mixed balance sheet and income statement approach to the determination of financial performance, whereby the all-inclusive concept of financial performance and the clean-surplus concept of equity are maintained. In the case of Barker and Penman (2016) this leads to a presentation of the income statement that pays close attention to the matching characteristics of the items of income and expense in different sections.…”

“…However, in our interpretation, these findings seem to suggest that there is a role for distinguishing realised and unrealised gains and losses. Penman's (2016) arguments underscore the importance of separate disclosure of realised and unrealised gains and losses. However, in Barker and Penman (2016), this does not go as far as to lead to recycling upon realisation because they attach great importance to the clean surplus relation for valuation.…”

“…Penman's (2016) arguments underscore the importance of separate disclosure of realised and unrealised gains and losses. However, in Barker and Penman (2016), this does not go as far as to lead to recycling upon realisation because they attach great importance to the clean surplus relation for valuation. Penman (2016: 127) raises the question whether the accounting for risky investments in business entities should communicate the risk ex ante or ex post.…”

“…Penman (2016: 127) raises the question whether the accounting for risky investments in business entities should communicate the risk ex ante or ex post. ASBJ (2006ASBJ ( , 2007, Saito (2011) and Penman (2016) argue that, except for assets and liabilities where measurement at fair value is appropriate, historical cost accounting, which recognises income and expenses when realised, gives information about the resolution of uncertainty in respect of the entity's risky investments. In doing so, historical cost accounting and the realisation principle provide investors with information that helps them to assess the amount, timing and uncertainty of future net cash flows.…”