Saturday, September 22, 2012

IASB Chair Says Concept of Prudence Permeates IFRS Despite Removal of Definition in Bow to Convergence with USGAAP

The concept of Prudence is alive and well in IFRS even though the definition has been removed in a bow to convergence with US GAAP, said Hans Hoogervorst in remarks to the European Federation of Accountants. Prudence was defined as the inclusion of a degree of caution in the exercise of the judgments needed in making the estimates required under conditions of uncertainty, such that assets or income are not overstated and liabilities or expenses are not understated. Prudence is designed to prevent earnings management. 

But the concept of Prudence, which essentially means if in doubt, be cautious, is still very much engrained in IFRS, said the Chair. For example, while fair values are often seen to be synonymous with exuberance, IFRS actually requires risk adjustments when fair values are measured using mark-to-model techniques. IFRS require liabilities to be recorded for guarantees or warranties even when they have not yet been called in.  Also, inventory is typically carried at lower of cost or net realisable value; noted the IASB Chair, again a prime example of exercising caution.  Impairment tests are required to ensure that the carrying amount in the statement of financial position is not greater than the recoverable amount of the asset.

IFRS also have very strict rules governing the balance sheet presentation, giving little room for off-balance sheet financing.  IFRS are also quite restrictive in terms of the netting of derivatives. The difference with entities reporting under US GAAP can be as big as 30 or 40% of the balance sheet. The IASB believes that derivatives are too important , and their net positions too volatile, to be relegated to the notes.