The Concept on Prudence: Dead or Alive?

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The Concept of Prudence: dead or alive?
FEE Conference on Corporate Reporting of the Future, Brussels, Belgium, Tuesday 18 September 2012
Hans Hoogervorst, Chairman of the IASB
______________________________________________________________ Ladies and gentlemen, I am grateful to the Federation of European Accountants for the opportunity to participate in today’s conference. As has often been said, Europe kickstarted the move towards global accounting standards when it and others adopted IFRSs from 2005. The accounting profession in Europe played a vital role in the success of this project. I and my fellow members of the IASB are extremely grateful to FEE and its membership for leading this important work.

The theme of today’s conference is corporate reporting of the future. There could be no better time to consider such a topic. In the last ten years we have seen nothing short of a revolution in financial reporting. Ten years ago, no one used international standards. Today, companies in more than 100 countries do so, including almost three quarters of the G20. Against any measure, this has been quite an achievement.

So, after the revolution, what comes next? What is the future of corporate reporting? There are various initiatives trying to address this question. One of the most important is the work to take a more holistic view of corporate reporting, known as integrated reporting. The goal of integrated reporting is to bring together many reporting requirements including sustainability, the environment, social issues as well as of course financial reporting. These topics are becoming more inter-dependent, and many investors want to understand the interplay between them. I also think for investors to properly understand financial statements, they are in need of non-financial key performance indicators. For example, a company might decide to cut back sharply on training and education of its employees. This decision might make its next quarterly statement look good, but it could be disastrous for long-term profitability. For all these reasons, I support this important initiative and am I happy to serve on the governing council of the IIRC.

While financial reporting is much further developed than integrated reporting, we are still struggling with very fundamental questions. Our Conceptual Framework has definitions of assets and liabilities, but we still do not find them completely satisfactory. While you 1

would expect accountants –of all people- to be able to make a clear distinction between mine and thine, we are still not quite sure how to distinguish equity from liabilities. Measuring the performance of an entity is also very hard. We measure Net Income, but then there is also Other Comprehensive Income, which keeps on growing without us being sure what it means. These are all the thorny issues that we need to resolve in the next phase of the revision of our Conceptual Framework. We are planning to write new chapters on elements, measurement and presentation, including a solid disclosure framework. This is perhaps the most important work we can undertake. Get the underlying concepts right, and you have sound and consistent reference points for the rest of our standard-setting work. The significance of this work is underlined by the fact that up to this day, the existing Conceptual Framework is still the subject of intense controversy. I am referring specifically to the Concept of Prudence. When the IASB revised the first chapters of the Conceptual Framework in September 2010, it replaced the concept of Prudence by Neutrality. Ever since, IFRSs have been periodically criticized for actually being imprudent, allegedly leading to overstated profits and/or understated liabilities. For example, critics blame the incurred loss model for understating losses on bad loans and the use of fair value accounting for inappropriately recognizing unrealised profits.

This criticism needs to be taken seriously. In previous...
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