WHAT REALLY MATTERS FOR INCOME PRESENTATION?
FORMAT VARIATIONS VS COHERENCE CONCERNS
ABSTRACT
Purpose This paper focuses on the incoherence concerns relating to the reporting of holding gains and losses, to elucidate how these can be rendered more coherent and meaningful.
Design On the basis of the Coherence Theory of Truth we discuss the incoherence of the IASB system, and highlight the possible contribution of the more coherent theoretical underpinnings of Economia Aziendale.
Findings The IASB and Economia Aziendale share a common focus on desiring clean surplus accounting and maintenance of the long-run operating capability. If the IASB would include in its system the founding notions of Economia Aziendale it could fully realise clean surplus accounting, better satisfying the needs of different users.
Value Economia Aziendale could contribute to the improvement of the current IASB accounting system, relevant for academicians and practitioners, and in general for policy makers, local standard setters and countries presenting similar characteristics to Italy.
Article classification: Conceptual paper
Keywords: Coherence, Economia Aziendale, Conceptual Framework, IFRS.
1. INTRODUCTION
The International Accounting Standards Board (IASB) has long been involved in reviewing the reporting format of performance, since 1996, when the former International Accounting Standard Committee (IASC) issued ED 53 Proposed International Accounting Standard – Presentation of Financial Statements. One of the aims of this ED was to focus attention on the issues relating to the appropriate reporting for holding gains and losses. However, seventeen years have passed, there have been a number of amendments to the reporting format of performance, but agreement has not yet been reached, thus leading to still on-going projects and related debate to attain a ‘conceptually robust’ accounting standard on the presentation of financial statements. The result is that holding gains and losses are still being treated inconsistently in the financial statements and the IASB is still looking for an appropriate place for them.
Yet in 2003 Newberry suggested that such conceptual robustness was difficult to accomplish because of the incoherence of the Conceptual Framework (CF), which is also related to the long-standing and still unsettled battle over concepts of income (Barker, 2004). More recently, Cooper (2007) stressed that there is little conceptual logic behind most of the current classifications and methods of presentation, and that this has an undeniable impact also on other projects of the IASB, because it is difficult to solve the other accounting problems without a suitable means to meaningfully present the related gains and losses. Also, other parties (e.g. companies, auditors, regulators, domestic standard setters) in response to the ED Presentation of Financial Statements: a Revised Presentation (2006) and ED Presentation of Items of Other Comprehensive Income (2010) have emphasised the need for a stronger theoretical foundation for the concept of comprehensive income, currently lacking within the CF. In this regard, Hans Hoogervorst, Chairman of the IASB, has recently recognised (2012) the need for clarifying the basis upon which different gains and losses are reported in different ways, and that in the on-going review of the CF the IASB will try to make income presentation more meaningful.
It is worth noting that the current IASB’s Conceptual Framework (2010) is capital-providers based and thus oriented towards a decision-usefulness approach. However, the IASB itself recognises that there are also particular subsets of primary users of financial reports other than capital-providers. Hence, the decision-usefulness of financial information should attain the needs of different kinds of users. As Whittington (2008) states essential characteristics of information to ensure decision-usefulness are the relevance and the faithful representation of the real-world economic phenomena that it purports to represent. In this respect, Alexander and Archer (2003) specify that the proper understanding of representational faithfulness is related to the preliminary comprehension of the concepts of reality and truth in the context of financial reporting and emphasise the possible relevance of a Coherence Theory of Truth (CT) in explicating the relationship between accounting and its objects. Drawing on Alexander and Archer (2003), in this research we assume that a conditio sine qua non for the fulfilment of decision-usefulness is the coherence of the information provided in financial reports. Coherence, in turn, implies that accounting standards have to be consistent with the Conceptual Framework and the Conceptual Framework has to be consistent with itself. Accordingly, this paper examines the reporting of holding gains and losses, by focusing on the claimed incoherence concerns related to the lack of conceptual bases.
In particular, for the purposes of this research, and in line with Newberry (2003), we refer to a traditional accounting theoretical approach. Specifically, we use the traditional Italian normative entity theory (Economia Aziendale, see e.g., Viganò, 1998; Zambon and Zan, 2000; Capalbo and Clarke, 2006; Viganò and Mattessich, 2007). Economia Aziendale is characterised by the importance of a unitary and coordinated view of the entity, which should be analysed from the three perspectives of management, organization and accounting to take into account the interdependences between all the operations. The main Economia Aziendale principles allow the provision of coherent theoretical underpinnings, which subsequently are helpful to provide coherent information in financial statements, that is useful for different kinds of users with various information needs. In this regard, what should be clarified is that we mainly refer to the theoretical accounting conceptions pursued by Economia Aziendale, rather than focusing on the Italian accounting practices. Indeed, although the theory has influenced in many ways the accounting practices, as Alexander and Servalli (2011) argue, these over the years have been affected also by other variables (e.g. law, regulation, taxation, legal profession practices).
A further essential element that justifies the reference to Economia Aziendale is related to the awareness that IFRS are widely used around the world, by countries presenting similar characteristics to Italy. These countries are indeed characterised by a manufacturing, retail and service tradition, with a vast majority of entities that are business-oriented rather than financial market-oriented (Hoogervorst, 2012). This clearly results in an increasing need for taking into account the real productive nature of such entities, rather than focusing only on financial orientation.
The remainder of the paper is structured as follows. Section 2 briefly examines the conception of coherence that we refer to. Section 3 discusses the issues of incoherence in the IASB treatment of comprehensive income. Section 4 describes the main characteristics of the coherent approach of Economia Aziendale. Section 5 highlights a possible way forward through the contribution of the Economia Aziendale. Section 6 analyses recent developments from IASB and EFRAG on the CF revision project, and Section 7 provides concluding remarks.
2. THE COHERENCE THEORY OF TRUTH IN ACCOUNTING
In this section we attempt to depict the conception of coherence that we refer to, in view of the fact that this represents a conditio sine qua non for the fulfilment of the information usefulness of financial reporting. Alexander and Archer (2003) emphasise that to be useful information must be relevant and faithfully represent what it purports to present, also suggesting that the proper understanding of representational faithfulness is related to the preliminary comprehension of the concepts of reality and truth in the context of financial reporting. In focusing on the concept of truth, the authors have devoted attention to the contrast between two different ‘definitions of truth’ in financial reporting. More precisely, they highlight that a particular view of truth, which they term Correspondence Theory of Truth (CTT), has been assumed by accounting standard setters. However, they contend that CTT is problematic in the context of accounting, thus proposing alternative theories of truth more helpful in explicating the relationship between accounting and its objects. Hence, they emphasise the possible relevance of a Coherence Theory of Truth (CT).
The coherence theory differs from its principal competitor, the correspondence theory of truth, in two essential respects, in that the competing theories give conflicting accounts of the relation between propositions and their truth conditions. The former states that the relation between propositions is coherence; on the contrary according to the latter the relation is correspondence. Moreover, according to the CT, the truth conditions of propositions consist in other propositions. The CTT, in contrast, states that the truth conditions of propositions are not (in general) propositions, but rather objective features of the world. Consequently, the criticism against CTT arises with regard to the fact that a belief cannot be true because it corresponds to something which is not a belief. Instead, the truth of a belief can only consist in its coherence with other beliefs, i.e. a belief is ‘true’ only to the degree that it coheres with other beliefs.
Given the above discussion, the argument which supports Alexander and Archer’s (2003) view is that CTT implies an objectified conception of economic reality, termed external realism (ER), based on the notion of the world as constituted of some fixed totality of mind-independent objects. However, the authors, in line with Searle (1995), reject ER as a valuable ontological basis for accounting, in favor of an internalist perspective, termed internal realism (IR). In fact, according to the latter, accounting objects do not exist independently of a conceptual scheme that relates accounting concepts to each other and to their empirical referents (Alexander and Archer, 2003). Consequently, switching from ER to IR (incompatible with CTT) forces the adoption of a different theory of truth, such as CT.
In this regard, it is also worth noting that the aversion against the CTT in favor of CT, although with various nuances and in several cases not explicit, is common also to other authors such as Shapiro (1997), Mattessich (2003) and Lee (2006). Subsequently, in accordance with these views, we provide here a basic and general formulation of the CT, by also discussing its implications for accounting in general. In particular, drawing on Dorsey (2006), who describes the CT in ethics, we summarise the main characteristics of his formal model. In the following sections this will be recalled as a guideline to run our discussion on the incoherence of the IASB accounting system, and to highlight the possible contribution of the Economia Aziendale, as a coherent accounting framework.
In his study Dorsey gradually examines the concepts of truth and coherence, providing a progressive formulation of these two by discussing the main implications of the related choices, and also examining the possible objections that arise against the model. The author addresses the examination of the concepts starting from a preliminary definition of truth, as follows:
T1: a normative sentence x is true if and only if it is part of a normative system and that system is coherent.
He clarifies that this formulation is not satisfactory, and emphasises that there is the need for relativizing truth to a system as follows:
T2: A normative sentence x is true in a normative system L if and only if x is part of L and L is coherent.
Also this formulation is not completely satisfactory given that it implies that the relativization of truth is necessary, but not sufficient. Indeed, if we accept T2 when the normative system is incoherent, any normative sentence is false. However, this problem can be avoided because even though a system is not coherent, if it is reasonable to think that a sentence x would be part of a system adjusted, expanded and rid of incoherence - through the Quinean doctrine of minimal mutilation - then it is true. Hence, Dorsey specifies that if there are a number of sentences held with confidence, these are regarded as the center of the web of belief and incoherent systems are revised in the light of these sentences in so far as is possible. Accordingly:
T3: A normative sentence x is true in a system L if and only if either x is a member of L and L is coherent, or x is a member of L* where L made coherent according to the Quinean doctrine of minimal mutilation yields L*.
At this point of his analysis Dorsey specifies that, although T3 is a good starting point, there is the need for enhancing the model by clearly characterizing coherence. Thus, drawing on Kirkham (1992), preliminary coherence is defined as follows:
«The term “coherence” as used by coherence theories has never been very precisely defined. The most we can say by way of general definition is that a set of two or more beliefs are said to cohere if and only if (1) each member of the set is consistent with any subset of the others and (2) each is implied (inductively if not deductively) by all of the others taken as premises or, according to some coherence theories, each is implied by each of the others individually».
In this regard, Dorsey further specifies that coherence alone is not sufficient because some relationships of mutual implication between the sentences are required. Therefore a second constraint to satisfy is the derivability (which also requires the use of non-normative sentences and that is satisfied if a sentence is derivable from all other sentences taken together).
Accordingly coherence can be formalised as follows:
C1: A normative system L is coherent if and only if, for all normative sentences x, if x is a member of L, x is consistent with all other sentences of L and is derivable by a system of deductive logic with all other sentences of L and any requisite non-normative sentences available as premises.
Furthermore, at this stage it is worth clarifying that a number of general normative principles are not always derivable via a system of deductive logic, thus an account of inductive generalization should be included. Also, there is the need to clarify clearly which is the relevant set of implications. Consequently:
C2: A normative system L is coherent if and only if, for all normative sentences x, if x is a member of L, x is consistent with all other members of L and their normative implications and is derivable by a system of deductive logic or inductive generalization with all other sentences of L and any requisite non-normative principles available as premises.
So, finally, the author takes T3 as the relevant truth predicate, wherein coherence is defined as above (C2). At this point a clarification is due: indeed, along his study Dorsey highlights that at a first glance three main objections related to derivability, circularity and mixed inferences can be moved against the model designed. However, he also contends that such objections are in reality problems without strong foundation, or at least eliminable, thus corroborating the correctness and usefulness of the proposed model.