The objectives of financial reporting: a historical survey and analysis

Abstract

This article is a survey and analysis of the succession of writings on the objectives of financial reporting during the past 90 years. Its aim is to contribute towards an understanding of the origins, significance, and limitations of conceptual frameworks. The article begins with a review of the extensive literature, including the series of recommended and approved conceptual frameworks, in the USA and then proceeds to examine the corresponding literatures in Great Britain, Canada, and Australia, followed by a discussion of the framework issued by the International Accounting Standards Committee in 1989 and Chapters 1 and 3 of the framework issued by the International Accounting Standards Board and Financial Accounting Standards Board in 2010. Summary remarks about Continental Europe conclude the survey. Attention is drawn to the criticisms of the objectives approach as well as to its possible perverse consequences for the remainder of the framework. In the course of the survey, there is an attempt to trace the evolution of stewardship and conservatism, or prudence, in the series of frameworks.

Keywords:

• conceptual frameworks
• conservatism
• financial reporting
• financial statements
• objectives
• prudence
• standard setting
• stewardship

Acknowledgements

This article was prepared as the basis for a plenary address at the ICAEW's Information for Better Markets Conference, held on 17 December 2012 in London. I gratefully acknowledge the comments and suggestions received on earlier drafts from Efrim Boritz, Philip Brown, Kees Camfferman, Dick Edwards, Rolf Fülbier, Sebastian Hoffmann, Todd Johnson, Jim Leisenring, Andrew Lennard, Ron Lott, Richard Macve, Garen Markarian, Alex Milburn, Michael Mumford, Chris Nobes, Mike Page, Jim Paul, Ken Peasnell, Christoph Pelger, Alfred Rappaport, Brian Rutherford, Brian Singleton-Green, George Staubus, David Tweedie, Tony van Zijl, Peter Walton, and Geoff Whittington, and on specific sections of earlier drafts from Matt Barrett, Derek Boothman, Graham Corbett, John Flower, Jon Glover, Axel Haller, Liesel Knorr, Paul Rosenfield, and Ron Salole. I am, of course, solely responsible for what remains.

Notes

^†When italics are used in quotations, they appeared as italics in the original. References to ‘he or she’ will be avoided: ‘he’ will imply ‘he or she’.

In order to keep this research project to a manageable size, I do not include coverage of the considerable literature on social reporting, sustainability reporting, and integrated reporting. I do not address the issue of objectives for the public sector.

In 1978, as will be seen, the FASB expanded objectives of ‘financial statements’ to ‘financial reporting’.

For historical studies of these efforts at building coherent theories, and eventually conceptual frameworks, in the USA, see Storey and Storey (1998) and Zeff (1999). A historical study of the development of the FASB's conceptual framework from 1973 to 1985 may be found in Gore (1992). Miller et al. (1998, chap. 4) provide an extensive discussion of the FASB's conceptual framework and its development. For international histories of conceptual frameworks, see Macve (1981) and International GAAP^® 2010 by the International Financial Reporting Group of Ernst & Young (2010, chap. 2). This was the last annual edition of the Ernst & Young handbook to contain the historical chapter.

I am grateful to Kees Camfferman for suggesting this dichotomy. This use of ‘functionalist’ is not related to the ‘functionalist perspective’ in sociology.

After reviewing the literature on these and other issues relating to stewardship, Rosenfield (1974, p. 132) concluded, ‘Confused terminology and the absence of analysis have deterred accountants from discovering just where [stewardship] leads’. Rosenfield's essay contains extensive quotations from the US literature between the 1940s and 1972 on stewardship and accountability.

Gjesdal (1981) reviewed the stewardship literature and formulated a generalised agency theory model in order to analyse the issue.

Lennard (2007) argued that a stewardship objective should be specifically acknowledged in the objectives of financial reporting. The European Financial Reporting Advisory Group (EFRAG) issued a paper (Stewardship/Accountability as an Objective of Financial Reporting (EFRAG 2007) which reported that 78% of the respondents to the IASB/FASB's discussion paper on objectives supported the view espoused by Lennard (EFRAG 2007, paragraph 3.2(a)). The article concluded that ‘[stewardship/accountability]’ should be ‘retained as an objective of financial reporting to ensure that there is appropriate emphasis on company performance as a whole and not just on potential future cash flow’ (EFRAG 2007, paragraph 7.1). The article was prepared by the staff of the UK ASB and was approved by the ASB, EFRAG, and the accounting standard setters in Denmark, France, Germany, Italy, and Poland. In January 2013, EFRAG, together with the French, German, Italian, and UK standard setters, again drew attention to the IASB's ‘controversial’ treatment of stewardship in Getting a Better Framework: Our Strategy (EFRAG 2013, paragraph 10).

Hans Hoogervorst, ‘The concept of prudence: Dead or alive?’, 18 September 2012. Available from: http://www.ifrs.org/Alerts/PressRelease/Documents/2012/Concept%20of%20Prudence%20speech.pdf

Another 25 states, again not including Delaware, require corporations to furnish shareholders with annual financial statements only upon their written request. The MBCA, as well as these 39 states, do not require that the financial statements be prepared in conformity with ‘GAAP’ or that they be audited by an independent public accountant (chap. 16, p. 94). According to the Secretary of State of Delaware, more than half of all publicly traded companies in the USA, including 63% of the Fortune 500, are incorporated in Delaware. See http://corp.delaware.gov/aboutagency.shtml

Only some state corporation laws refer to the ‘authoritative’ literature in accounting (e.g. ‘GAAP’), but not as a requirement, in regard to the preparation of financial statements. Until 2012, California was the only state requiring that GAAP be the arbiter of accounting terms, such as profits and retained earnings, when directors declare dividends. But California no longer has the GAAP requirement. I am grateful to Matt Barrett for this information.

Despite its title, the memorandum dealt mainly with the conduct of balance-sheet audits. Yet it contained considerable advice on format, classification, measurement, and disclosure in the balance sheet and profit and loss statement. It was also published in the June 1917 issue of The Journal of Accountancy under the title ‘Uniform Accounting’.

Paton's view is consistent with Modigliani and Miller's (1958) fundamental theorem that (absent tax differentials etc.) the value of a firm is unaffected by how that firm is financed and whether its distributions are paid as interest or dividends. I am grateful to Richard Macve for this insight.

It is interesting that interest charges and dividends are shown together, as payments to the providers of capital, in the value added statement illustrated in The Corporate Report (1975, p. 50) – see Section 4.2.

Kohler (1963, p. 39) and Littleton (see below) were supporters of the stewardship view, coupled with strict historical cost accounting, while Paton favoured the use of current values. This difference may not have led to easy discussions within the committee.

On pages 43–44, Paton and Littleton press the argument earlier seen in Paton's Accounting Theory that interest charges, as viewed from the point of view of ‘the enterprise as an economic entity and a center of managerial activity … are not operating costs but represent a distribution of income, somewhat akin to dividends’.

In fact, the original law academic invited by the Foundation was William O. Douglas. But when he was appointed to the SEC in January 1936, Moore, his colleague at Yale University, succeeded him.

The authors' characterisation of ‘investors’ as outsiders is curious. Are shareholders, i.e. actual investors, to be regarded as outsiders?

It was impossible to trace the sources of the authors' recommended practices. Virtually all of the many source notes at the end of the monograph were to statutes, court opinions, and legal treatises, undoubtedly supplied by Moore, the lawyer. Hatfield wanted to cite the views of leading accounting academics and practitioners as support, but Sanders, the lead author on the project, demurred (Zeff 2000, p. 178).

All of the Accounting Research Bulletins issued from 1939 to 1953, including the reports of the committee on terminology during that period, have been compiled in Zeff and Moonitz (1984, vol. I). The full text of all of the ARBs may be downloaded from the digital collections of the University of Mississippi. See http://en.wikipedia.org/wiki/Accounting_Research_Bulletins

From 1939 to 1941, the Institute's president was the ex officio chairman of the committee, although May, in practice, sat in the chair. May served as the de facto chairman for two years and then remained on the committee for another four years. Paton and Littleton were two of the three academics serving on the committee.

Four of the five references to ‘users’ were in a single bulletin.

Littleton referred to modification of the dividend provisions in a number of state corporation laws since 1927, begun by Delaware, towards permitting dividends to be declared out of current net earnings. For a discussion of these provisions, see Zeff (1961, pp. 745–749).

For a discussion of the undeviating opposition by the first four SEC chief accountants, including Barr, to upward departures from the historical cost of tangible assets from the 1930s to 1972, see Zeff (2007). Two of Barr's predecessors as chief accountant, Carman G. Blough and William W. Werntz, also wrote comments in the study in which they rejected the authors' recommendations (Sprouse and Moonitz 1962, pp. 60–63, 79–82).

The full text of the APB's Opinions may be downloaded from the digital collections of the University of Mississippi. See http://en.wikipedia.org/wiki/List_of_APB_Opinions

There were occasional descriptive references to ‘annual reports to stockholders’, which I interpreted as a ‘boilerplate’ description of the annual report in which the financial statements are included.

For a list of his publications, see Staubus (2000, pp. 343–345).

A helpful discussion and synthesis of the decision-usefulness approach, drafted by Staubus, appears in Statement on Accounting Theory and Theory Acceptance (AAA 1977, pp. 10–21). The point was made that, in such major theoretical works as Canning (1929), MacNeal (1939), and Chambers (1966), the authors ‘apparently rejected the idea of basing an accounting theory on the decision models of specific user groups’ (AAA 1977, p. 12).

Young (2006) argues that decision usefulness, as used in the US conceptual frameworks, leads to the construction of users who desire only the information that the framework has stated is of interest to them, a circumstance which impedes the development of a broader societal role for accounting.

By coincidence, the AAA president for 1965, Robert K. Mautz, and the president for 1965–1966, Herbert E. Miller, both of whom signed the preface, had chaired the AAA principles committees in 1957 and 1948, respectively.

The supervisor of Sorter's doctoral thesis at Chicago was also William Vatter. I have queried Sorter about this speculation, and he replied that he never read Staubus' doctoral thesis and does not remember his review of Staubus' book. Communication from Sorter, dated 18 July 2012.

Communication from Sorter, dated 18 July 2012.

The AAA's president charged a committee to review companies' external reporting practices in the light of the ASOBAT recommendations (AAA 1969a).

The recommended use of current costs provoked a dissent from the lone practitioner on the committee, Russell H. Morrison, of Arthur Andersen & Co. He said, ‘in my judgment there have yet to be devised feasible and acceptable methods for objectively determining current cost, except perhaps in such areas as marketable securities’ (AAA 1966, p. 98).

By then, Sterling (1970) was well along towards writing his treatise advocating the use of exit prices.

The ASOBAT committee stated (AAA 1966, p. 22) ‘It is not the function of the accountant to dictate the decision models for users of accounting information’, a passage probably inserted by Sorter.

When describing the ways in which owners would use the financial statements, the Statement said, ‘retain, increase, or decrease proportionate ownership; evaluate the use and stewardship of resources by management’ (APB 1970, paragraph 44).

At the 4–6 September 1968 meeting of the Board, Catlett discussed a memorandum he had prepared for the Board to argue the need to develop a normative statement of the purposes and objectives of financial statements. He was then made chairman of a new Board subcommittee to carry the proposal forward, but the subcommittee never reported. Minutes of meeting of 4–6 September 1968 of the APB, p. 15, and private memoranda provided to me by Arthur Andersen & Co. in 1982–1983.

Communication from Paul Rosenfield, dated 17 July 2012. He began the drafting in early 1966, and ASOBAT did not appear until September 1966. Also, in 1968–1969, a task force of the AAA advised the APB's committee and research staff on the draft of the document at that stage. Minutes of meeting of 5–8 March 1969 of the APB, p. 13. The chairman of the task force was Robert Sprouse. Two of its other four members were Robert Sterling and Charles T. Zlatkovich, who had chaired the ASOBAT committee. ‘Miscellaneous Association Notes’ (AAA 1969b).

The Institute's leadership would have been aware of a speech that Trueblood (1970, p. 62) gave to the AAA on 27 August 1969, in which he called for ‘the development of a statement of accounting objectives’. He said, ‘The lack of a set of consistent objectives – and the absence of a statement of the basic purposes of financial reporting – are, in my view, a main reason for the present piecemeal approach to the Board's task’.

Sorter and Gans (1974) and Anton (1976) have helpfully classified the 12 objectives into tiers or hierarchies.

That Sorter (1973), in an article that appeared just after the Study was published, did not refer at all to the qualitative characteristics leads to an inference that these were not inspired by the staff.

ASOBAT (AAA 1966, pp. 13, 29) made a somewhat similar suggestion, proposing that accountants ‘report in terms of interval estimates or probability distributions’, but it was not said to be motivated by the desire to avoid reliance on conservatism.

One can see in the statement of financial activities the influence of Sorter's ‘events’ approach in his 1969 article, cited in Section 3.2.

The Study Group said that financial forecasts should be provided ‘when they will enhance the reliability of users’ predictions'. But this statement was immediately preceded by ‘An objective of financial statements is to provide information useful for the predictive process’. This section on financial forecasts was written with delicate wording, because Davidson (1973, p. 8), a member of the Study Group, wrote that there was no unanimity on the principle of recommending the inclusion of forecasts with the financial statements.

Herwitz's (1974) paper was published in Volume 2, Selected Papers of the Study Group's report.

Burton (1974a), the SEC chief accountant, made it known that the SEC was ‘encouraged’ that the FASB was using the Trueblood Report as a framework for a statement on objectives.

Staubus (2003, pp. 184–185) has written about the speaking campaign at chapter meetings of the Financial Executives Institute (FEI) by Mautz on behalf of the audit firm of Ernst & Ernst against the decision-usefulness approach to objectives, because, Staubus believed, Mautz and his firm feared that it would lead to the use of current value accounting. Beresford (1983, p. 66), his partner in the firm, discussed this campaign in 1977 and said that its motive was to ‘educate’ financial executives about ‘the potential dangers’ which the framework project presented, namely, a possible movement towards ‘an entirely new financial reporting model based largely on current values’. Also see Gore (1992, pp. 94–95). As noted in Section 3.4, the FEI's research foundation published a report in 1973 which found that most preparers and users viewed financial reporting as a stewardship function.

Agrawal (1987, p. 171) has written, ‘it is not clear which of the objectives are really intended to be achieved by financial reporting’. SFAC No. 1 was deficient in not apprising the reader, as did the Trueblood Report, which were the salient objectives as one reads the text. A useful restatement of the objectives may be found in SFAC No. 2 (FASB 1980, paragraph 22).

SFAC No. 1 (FASB 1978) was not carefully edited to assure a consistent use of terminology for the various classes of users. In the long list of potential users in paragraph 24, ‘potential investors and creditors’ was shown but not also present investors and present creditors. Yet in the quotation keyed to this footnote, ‘present and potential investors and creditors’ was used. In paragraph 26, the usage was ‘[s]ome investors and creditors or potential investors and creditors’. In paragraph 35, ‘investors’ was defined to include ‘equity securityholders and debt securityholders’.

The FASB's counterpart of Chapter 10 in the Trueblood Report on qualitative characteristics of reporting was in SFAC No. 2 (FASB 1980).

Solomons had been commissioned to draft the statement by Staubus, who was then the FASB's director of research and technical activities.

Moonitz (1961, p. 47), in his postulates study, accorded conservatism no more than a constrained approval: ‘The proper role of conservatism in accounting is to insure that the uncertainties and risks inherent in any given business situation are given adequate consideration’.

Sterling (1972) has illustrated how difficult it is to move from ‘usefulness’ to the selection of valuation methods. Carsberg et al. (1977) have amply illustrated the extreme complexity one encounters when moving from a shareholders' valuation model, using portfolio theory, towards identifying the future events which they wish to forecast in order to be able to assess alternative types of information.

Horngren (1981), who served from 1968 to 1973 as a member of the APB, wrote that a conceptual framework ‘is likely to help provide power to the [FASB]’ (p. 88). Sorter et al. (1974, p. 17) wrote, ‘Stating objectives of financial statements would strengthen the accounting profession's position for establishing financial accounting standards in the private sector’.

Macve (1981, pp. 65–71) has also raised the spectre of these conflicts of interests. A practical illustration of this heterogeneity was the profound differences in view expressed about the objectives of financial statements as between preparers and others in a conference on the conceptual framework (Wharton 1977). Another illustration was the finding by a puzzled FASB chairman that only 37% of respondents to the FASB's discussion memorandum on the conceptual framework agreed that providing information useful for making economic decisions was an objective of financial accounting. Dopuch and Sunder (1980, pp. 12–13), who said they were puzzled at the chairman's puzzlement, argued that auditors, who probably seek to maximise their own wealth, might well view such an objective as exposing them to risk without correspondingly higher compensation. The AAA committee that wrote the Statement on Accounting Theory and Theory Acceptance (AAA 1977, p. 34) said, ‘Since individuals in a multi-person setting have diverse preferences, no single set of standards for external reporting is likely to be consistent with those diverse preferences’.

In the USA, the boards of directors of publicly traded companies were formally tasked with appointing the auditor, and since the Sarbanes-Oxley Act of 2002, the directors' audit committee has had that responsibility.

See, for example, Dicksee (1920) and De Paula (1934). For a historical perspective, see Yamey (1960, p. 17).

Passage taken from the opinion of Lord Jauncey of Tullichettle in Caparo Industries plc (Respondents) vs. Dickman and others (Appellants), Judgement, 8 February 1990, p. 48, at http://www.bailii.org/uk/cases/UKHL/1990/2.html

Reporting on an interview study and a questionnaire survey of British qualified accountants, Carsberg et al. (1974, p. 173) concluded, ‘The traditional stewardship objective of accounting is still widely acknowledged as important. There appears to be a growing consensus, however, that the provision of information to assist shareholders with their investment decisions should be recognized as a second important objective of accounting statements’.

Both of these letters plus a reply by Stamp were reproduced in Stamp and Marley (1970, Appendix I).

Interview with Derek Boothman, 24 August 2012.

That Stamp (1980) was an advocate of the wide range of users and their needs was confirmed by his recommendations in the same direction in Corporate Reporting: Its Future Evolution, which is discussed in Section 5.2.

In Statement of Standard Accounting Practice (SSAP) 2, ‘Disclosure of Accounting Policies’, approved by the ASSC and issued in November 1971, prudence was said to be one of the four fundamental accounting concepts.

See ‘1973–1974 stock market crash’, http://en.wikipedia.org/wiki/1973%E2%80%931974_stock_market_crash

Value to the firm is also known as deprival value. For an explanation of what is meant by deprival value, see Solomons (1966) and Parker and Harcourt (1969).

In Appendix 5, the working party gave its assessment of how each of the six measurement bases complied with criteria under the headings of theoretical acceptability, relevance to user needs, and practicality.

Interview with Derek Boothman, 24 August 2012.

Communication from Ken Peasnell, dated 26 July 2012.

In 1981, Tom Watts (1981), the ASC chairman, in an article, ‘Planning the Next Decade’, did not even mention The Corporate Report. For a further discussion of developments at the ASC in the wake of The Corporate Report, see Tweedie (1981, pp. 175–179).

At a conference held in September 1970, Stamp cited the ‘urgent need to begin immediately on research’ to define the objectives of financial statements' (ICAEW 1970, p. 170).

This remark by Stamp was related to me by Ken Peasnell in a communication dated 26 July 2012.

The value-added statement has had periods of popularity in Germany and the Netherlands as well as in South Africa, and since 2007 Brazil has required listed companies to publish a value added statement.

A Green Paper is issued by the UK government to initiate discussion of proposals for legislation. At this stage there is no commitment to proceed with enacting the legislation.

David (later Sir David) Tweedie was an influential member of the committee.

Guidelines was republished with a new foreword by Garland Publishing, Inc. in 1997.

SSAP 2 (ASSC 1971), ‘Disclosure of Accounting Policies’, while not a framework, did enumerate and discuss four ‘fundamental accounting concepts’ as well as ‘accounting bases’ to apply the concepts.

Solomons (1989) noted in passing (p. 52) that deprival value was ‘the concept that was espoused by’ the working party that prepared The Corporate Report. In fact, deprival value was one of several concepts espoused in that report, but it seemed to be the one that the working party favoured the most (ASSC 1975, paragraph 7.37).

In 1990, the ASB had succeeded the ASC as the British accounting standard setter. David Tweedie chaired the ASB from 1990 to 2000, when he was appointed to be the chairman of the IASC, to take effect in 2001, when the IASC was reorganised as the IASB. As noted above, Tweedie was an influential member of the ICAS research committee which wrote MCRV.

I am grateful to Mike Page for drawing my attention to the position of stewardship in this initial exposure draft. Readers may wish to consult the proceedings from a conference held to discuss the third exposure draft, issued in March 1999 (Mumford and Page 1999).

As noted above, Tweedie had been a member of the ICAS research committee that produced MCRV in 1988. One should take note of the standing given to stewardship in the ASB's conceptual framework. It will be mentioned in Section 8 that Tweedie was one of the two dissenters to the IASB's discussion paper on objectives that did not mention stewardship.

In view of Skinner's bibliography for the chapter, which consisted of works from seven US authors (or sets of authors) and one British author, a reader infers that there was little in the Canadian accounting literature to stimulate his thinking or to cite as precedent.

This passage was quoted with favour by Solomons (1989, p. 8).

Stamp trained with Clarkson, Gordon & Co. in Toronto in the 1950s, qualifying as an Ontario CA before becoming a partner in Montréal in 1962.

Mumford (1993) questioned the feasibility of Stamp's survey.

Stamp used ‘prudence’ when he approved of the practice and ‘conservatism’ when he disapproved of the practice. The reader does not know if this usage was deliberate or not.

In Section 5.4 all detailed paragraphs cited are to be found in the CICA Handbook, with dates as indicated.

For an article explaining AcSC's ‘milestone’ achievement on financial accounting concepts, see Walker (1988).

Solomons (1986a, p. 116) gave this same argument in support of a conceptual framework: ‘I know of no better way to reduce accounting's vulnerability to political pressure’. See the quoted statement from former FASB Chairman Donald Kirk in Section 3.5.1.

The Accountancy Research Foundation was renamed the Australian Accounting Research Foundation (AARF) in 1975.

SAC 2 (and SAC 3, mentioned below) were prepared by the Public Sector Accounting Standards Board (ASB) of AARF and by the Accounting Standards Review Board.

In SFAS No. 2, the FASB had written, ‘Reliability does not imply certainty or precision. Indeed, any pretension to those qualities if they do not exist is a negation of reliability’ (paragraph 72).

Hoogervorst, ‘The concept of prudence: Dead or alive?’ 18 September 2012. Available from: http://www.ifrs.org/Alerts/PressRelease/Documents/2012/Concept%20of%20Prudence%20speech.pdf

Communication from Jim Leisenring and Ron Lott, dated 13 August 2012.

Whittington (2008a, pp. 143–145) provided a statement of his views on stewardship within the framework of the objective of financial reporting. A third Board member, Anthony Cope (also of British upbringing and education who had made his professional career in the USA), voted against the discussion paper for the same reason, but he chose not to join Tweedie and Whittington in their dissent. Communication from Anthony Cope, dated 19 September 2012. The historical role of stewardship in Britain was discussed in Section 4.1. The AAA's Financial Accounting Standards Committee (AAA 2007, p. 231) published a comment on the discussion paper. The primary author of the comment was George J. Benston. The committee gave its characterisation of the boards' position on the primary use of financial statements as follows: ‘The primary use of information in financial reports is for investment decisions (equity and debt); stewardship is mentioned, but almost in passing’. The committee then made this categorical comment:While stewardship is often claimed to be well served by a focus on investment decisions (or valuation), the claim is logically false. Information useful for stewardship purposes may or may not be useful for valuation purposes and vice versa. This has been documented in the academic literature during the last three decades. [No citations to that literature were supplied.]

Communication from Todd Johnson, dated 26 August 2012.

One can say about the USA that the objectives of financial reporting have been framed by the aim of the Securities Acts and therefore of the SEC, which is investor protection, meaning investors in equity and debt securities.

I am grateful to Kees Camfferman for supplying this reference.

FEE (1997) compared the conceptual frameworks of the 15 EU countries plus the Czech Republic, Norway, Hungary, and Switzerland.

For a discussion of the motives and opportunities for previous accounting attitudes to persist after countries adopt IFRS, see Nobes (2006).

For more on the early influence of the COB, see Lande and Scheid (1999, pp. 93–94).

Rappaport's (1986) Creating Shareholder Value, which led the movement beginning in the 1980s towards placing emphasis on ‘shareholder value’, has had an impact on management and academic thinking in Germany, the Netherlands, and perhaps elsewhere in Europe. See Coenenberg (2003), Busse von Colbe (1997, p. 271), and Gelderloos et al. (1994). I am grateful to Rolf Fülbier and Kees Camfferman for these references.

Communication from Warren McGregor, dated 8 January 2013.