Majority of investment professionals favour faithful representation over prudence
Investment professionals have voted almost two-to-one in favour of “faithful representation” rather than “prudence” as a fundamental characteristic of financial information.
The survey by the CFA Society of the UK found that 61 per cent of the 277 respondents would prefer faithful representation compared with 31 per cent who preferred prudence (with eight per cent responding ‘don’t know’).
The results were fed into CFA UK’s response to the IASB’s consultation on its Conceptual Framework, which has reignited the debate about whether the concept of prudence should be reinstated.
Survey respondents who supported faithful representation – neutral accounting, free from bias and error – regarded prudence as being more subjective, resulting in “higher hidden risk”. One respondent said: “A rule of prudence would only lead to analysts having to build in a correction determining how prudent they thought management was being.”
The need to correct arose from the perception – not universally held – that prudence would lead to conservative accounting. Asked whether they would expect to adjust data for a conservative bias, if prudence were a fundamental characteristic, 51 per cent said yes, 29 per cent said no and 20 per cent answered that they were unsure.
Comments on the extent to which they would adjust included: “not much”, “significantly”, five to 10 per cent and “can’t estimate”. One said they would “review the assumptions used for conservatism and adjust to reflect a more ‘realistic’ view”. Others said it would depend on the company.
Among those who supported prudence, one said it would lead to more “trust from users” and another that there were too many “loopholes” in the faithful representation concept. Some felt that the two should work together – by incorporating prudence in assumptions, for instance.
The financial reporting and analysis committee (FRAC) of CFA Society of the UK supported faithful representation and neutrality in its response to the International Accounting Standards Board (IASB).
“We know that many numbers in the accounts involve estimates and judgments. It is simplest to assume that the aim has been to arrive at the most credible and robust estimate,” it said.
Any bias towards conservatism would be impossible to quantify consistently, and so would detract from the credibility of numbers that are supposed to reflect the underlying economic reality, it added.
Jane Fuller, chair, FRAC, says: “In our response to the IASB we suggested the explanation of faithful representation could be improved by spelling out that it means capturing the underlying economic reality - or substance over form. Application of the concept in uncertain conditions could be enhanced by reference to ‘a degree of caution’ – but not a conservative bias.
“Any bias of management towards optimism breaches the concept of neutrality and should be leaned against by auditors and independent directors. Users of accounts should be aware of the limitations of numbers that involve estimates, judgments and models, and which only relate to the balance sheet date.”
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