Business-model (intent)-based accounting

Abstract

We discuss how basing financial reporting on an entity's business model is, in effect, basing financial reporting on management's intent with respect to the use, transfer or other disposition of an asset or liability. We provide several examples of existing International Financial Reporting Standards and US Generally Accepted Accounting Principles that permit or require intent-based accounting. We describe the meaning and consequences of basing the accounting for financial assets on management's intentions for realising value from those assets. We analyse the positive and negative features of intent-based accounting in the context of the Financial Accounting Standards Board's and International Accounting Standards Board's conceptual frameworks, specifically, the qualitative characteristics relevance and comparability and the objective of financial reporting, and apply that analysis to existing and proposed guidance for measuring financial assets. We also discuss evidence from academic research on the measurement of financial assets.

Keywords:

• business-model-based accounting
• comparability
• financial assets
• intent-based accounting
• objective of financial reporting
• measurement
• relevance

Acknowledgements

The authors thank Lynn Rees for his helpful comments. This paper was prepared for presentation at the Information for Better Markets Conference, December 20, 2011, supported by ICAEW's charitable trusts. The views expressed are those of the authors and do not represent positions of the FASB. Positions of the FASB are arrived at only after extensive due process. We appreciate the comments of an anonymous reviewer.

Notes

As discussed in Section 3, this reasoning also appears in IFRS 8, Operating Segments (IASB 2006), where the way an entity is managed (that is, performance evaluation and resource allocations) and the way information is provided to management determine both segment definition and disclosed information.

We do not consider the (aberrational) case in which management does not follow its own business plan or strategy, acknowledging that such aberrations could be associated with fraud. Specifically, we do not question whether management's intentions can be reasonably ascertained from its actions.

ICAEW (2010) notes that financial reporting has traditionally embodied implicit or explicit assumptions about the reporting entity's business model.

The FASB rejected this accounting, in the development of SFAS 146, Accounting for Costs Associated with Exit or Disposal Activities (FASB 2002). Paragraph B 21 states, in part:

‘The Board concluded that because an exit or disposal plan merely reflects an entity's intended actions and, by itself, does not create a present obligation to others for the costs expected to be incurred under the plan, an entity's commitment to such a plan, by itself, is not the requisite past transaction or event for recognition of a liability’.

We acknowledge that neither the FASB nor the IASB has recently considered the impairment test for inventory or the measurement of impaired inventory. Thus, the differences in the accounting for inventory and plant, property and equipment may exist in part because standard setters do not regularly revisit all standards and issues.

In contrast, IAS 38, Intangible Assets (IASB 1998b) specifies management's intent to ‘complete the asset and use it or sell it’ (para 57(b)) as one of several criteria for separate recognition of an intangible asset arising from internal development activities.

However, the basis for conclusions of SFAS 13 (para 60) states that the intent of the FASB was to develop a principles-based standard. The paragraph states that the provisions of the standard ‘derive from the view that a lease that transfers substantially all of the benefits and risks incident to the ownership of property should be accounted for as the acquisition of an asset and the incurrence of a liability by the lessee …’

There are other intent-based provisions in IFRS 9. An entity may designate an equity instrument irrevocably to be ‘not held for trading,’ with consequences for how changes in fair value of that instrument are displayed (para 5.4.4). An entity may reclassify financial assets when the business model for those assets changes (para 4.9).

The document is available on the FASB's website (fasb.org) in the section titled inactive joint FASB/IASB projects.

The Staff paper also distinguishes between direct (all-in-one-step) value realisation, for example, sale of a marketable security for cash, and indirect value realisation, for example, converting raw materials to finished goods and then selling those goods. We do not discuss this distinction in this paper.

The SEC complaint is available at http://www.sec.gov/litigation/complaints/comp17829.htm.

The memo is part of the public record in the WorldCom case and is available at http://fl1.findlaw.com/news.findlaw.com/hdocs/docs/worldcom/6212402sullimemo.pdf.

The case against basing measurement on management intent perhaps also could be supported by the enhancing qualitative characteristic of verifiability in Concepts Statement 8. If management intent is a state of mind, it may not always be amenable to verification. However, if the evaluation of the business model for financial instruments requires consideration of not only management's intent for the financial instrument but also management's actions to manage the instruments in a portfolio for either for sale or collection, the latter management action is likely subject to verification.

Our conclusions about exit value measurements are limited to financial assets. Conclusions about initial and subsequent measurement of nonfinancial assets and financial and nonfinancial liabilities are outside the scope of this analysis and would likely be affected by considerations we have not discussed (for example, cost–benefit considerations).

The objective of this section is not to provide a comprehensive literature review of research findings, but rather to point to empirical research support for the model described in Section 6.

Other research provides similar evidence on the relation between fair values of financial instruments and share prices (see Landsman 2007 for a review of this literature).

We are aware of published and unpublished research that analyses comparability, measured as similarity in the statistical association between a summary financial reporting outcome (such as income or book value of equity) and summary indicators of fundamentals (such as cash from operations or share returns). These analyses are not directly on point for our discussion, which considers comparability in the context of individual items or arrangements, not in terms of summary outcomes.