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Financial disasters
In reaction to economic disasters and enforced legislation, the accounting profession formulated rules and recommendations on an ad hoc basis to provide guidance to accountants (Storey & Storey, 1998).72 The emergence of principle based accounting can be attributed to the economic crises between 1844 -1937 (Hoffmann & Detzen, 2013).
The Railway Mania during 1845 -1847 stimulated an improvement in the disclosure levels of the financial reports (McCartney & Arnold, 2003; Odlyzko, 2012; Bryer, 1991; McCartney & Arnold, 2010; Arnold & McCartney, 2002) (section 2.5.1). Both the quantity and quality of the information disclosed improved. The conceptual basis of reporting changed “from a cash to an accrual basis” (McCartney & Arnold, 2010:401) and the standardisation of depreciation treatment was developed. These changes still happened in what is called a laissez-faire (unregulated) system of financial regulation (Hoffmann & Detzen, 2013). The Great Depression, starting with the Wall Street Crash on 24 October 1929 ending in 1933, introduced the beginning of a more regulated system with the
establishment of the SEC in 1934. These financial disasters directly caused the search for accounting theories. In reaction to the Great Depression two important documents regarding accounting principles were published, “A Tentative Statement of Accounting Principles Underlying Corporate Financial Statements” (American Accounting Association, 1936) and the “Statement of Accounting Principles” by Sanders, Hatfield and Moore (Gaffikin, 2008; Storey & Storey, 1998). From 1938 to 1973, professional bodies mainly summarised accounting practices without a theoretical basis and reacted on an ad hoc basis to the requirements of the SEC (section 2.5.2, Table 2.3). The importance of a theoretical basis is emphasised by the replacement of the APB due to the lack of developing accounting principles. From 1960 to 1973 a lot of discussion on accounting postulates and principles were conducted (Zeff, 1982).
Since 1973, one of the most prominent financial crises was what is today known as the subprime loan crisis. On September 26, 2008, failures of large financial institutions in the U.S. developed into a global crisis resulting in bank failures and sharp reductions in equity values in Europe (Appendix C). This crisis started in the summer of 2007 when U.S. subprime losses triggered disruption in the global financial system (Deloitte., 2015). The subprime loan crisis emphasised the interconnected nature of capital markets (Mackintosh, 2014) and underlined the need for global accounting standards. The importance of the financial crises for accounting standard setting is emphasised by a hit of 2 400 results when a search for the term “financial crisis” is conducted on the IASB web site (IASB, 2015a). A Financial Crisis Advisory Group (FCAG) was formed to “consider how improvements in financial reporting could help enhance investor confidence in financial markets” (IASB, 2015b:1) after the subprime crisis. The following are some of the issues dealt with by the FCAG:
• “Areas where financial reporting helped identify issues of concern, or created unnecessary concerns, during the credit crisis.
• Areas where financial reporting standards could have provided more transparency to help either anticipate the crisis or respond to the crisis more quickly.
• Whether priorities for the IASB and the FASB should be reconsidered in light of the credit crisis.
• Potential areas that require future attention of the IASB and the FASB in order to avoid future market disruption.
• The implications of the credit crisis for the interaction between general-purpose financial reporting requirements for capital markets and the regulatory reporting, particularly for financial institutions.
• The relationship between fair value and off-balance sheet accounting and the current crisis, both during and leading up to the crisis.
• The findings and relevance of conclusions of various studies underway, including the US Securities and Exchange Commission study under the Emergency Economic Stabilization Act of 2008.
• The need for a due process for accounting standard-setters and its implications on resolving emergency issues on a timely and inclusive basis.
• The independence of accounting standard-setters and governmental actions to the global financial crisis” (IASB, 2015b:1).
Three round tables (Asia, Europe and North America) were organised by the IASB and the FASB on the global crisis.73 A direct result of the subprime crisis was the elevation of the revision of IAS 39 being replaced by IFRS 9 Financial Instruments (IASB, 2015c). IFRS 9 is described by the IASB (2015c:1) as a “comprehensive response to the financial crisis”.
It is difficult to prove a direct link between the effect of the subprime loan crisis and the development of the CFfFR. The development of the CFfFR is influenced by the subprime loan crisis in two possible ways. Firstly, the subprime crisis could indirectly be responsible for the suspension of the joint conceptual framework project between the FASB and the IASB. Both the IASB and the FASB had financial reporting crises on hand to manage as is evident from the steps implemented by the IASB (and the FASB) to manage the crisis. On a Joint Board Meeting of the FASB and the IASB on November 19, 2010 regarding the Conceptual Framework project, “because of the priority placed on other projects, the Boards concluded that they cannot devote the time necessary to properly address those issues in the near future” (FASB and IASB, 2010:1). Secondly, the developments on individual standards after the subprime crises feed back into the revision of the CFfFR as it has been taken into account as the CFfFR is being revised (IASB, 2013a).
The subprime crisis could be seen as a stimulus in the stimulus/response process of the development of the CFfFR, which corresponds with the effect of the previous major crisis, the Great Depression, which served as a major stimulus to search for accounting postulates and principles.
Legitimacy and credibility
According to Hines (1989), perceived from a social constructivist perspective the major reason for the development of conceptual framework projects by standard setting bodies is to provide legitimacy to their accounting standards and not due to functional or technical considerations. The discussion on the history of the CFfFR supports the social constructivist theory of Hines (1989) (see sections 2.6, 2.7 and 2.8). In support of Hines’ (1989) perspective, the IASC only started its conceptual framework project after it was criticized for not having an explicit or implicit framework of objectives for setting accounting standards (Alexander et al., 2013; Zeff, 2012). In the case of the AICPA it was a survival strategy not to let the SEC take over the standard setting process (Alexander et al., 2013). Alexander et al. (2013:7) agrees in principle with Hines (1989) stating the motives of privately regulated standard-setting bodies to develop a conceptual framework “is not necessarily intended to have operating effects but is rather crucial, from a political stand point”. The motive for a private standard-setter is to maintain professional power when its legitimacy is questioned (Power, 1992) or “when the credibility of financial reporting standards are in doubt” (Alexander et al., 2013:7). Legitimacy and credibility can be obtained by various means. An important aspect in the acceptance of a conceptual framework and accounting standards is the degree of representativeness when a conceptual framework or an accounting standard is drafted (Alexander et al., 2013; Hines, 1988; Peasnell, 1982; Power, 1992; Stamp, 1980). According to Peasnell (1982:254) for a standard setting body to obtain credibility it needs “to demonstrate that it is trying by logical means to develop accounting standards based on principles of general appeal”.
The degree of credibility required by a standard setting body differs depending on its level of independent status. In cases where accounting standards do not have to be approved by a statutory body, that standard setting body needs a higher degree of credibility to obtain legitimacy (Alexander et al., 2013). When both the responsibility and power of developing accounting standards are situated within one body, the need for a conceptual framework by that body is essential in order to obtain credibility (Alexander et al., 2013; Peasnell, 1982). In the case of the FASB, the approval by the SEC of the accounting standards set by the FASB provides credibility to the accounting standards.
In the case of the IASB, there is no statutory body approving its accounting standards. Because of its independence, the IASB’s political credibility is weak and a conceptual framework is the best way to show that its accounting standards are developed “in a fair, logical and highly professional manner” (Alexander et al., 2013:8). According to Burlaud and Colasse (2011:23) the credibility of the IASB’s accounting standards are founded on procedural and substantial legitimacies.
The search for procedural legitimacy and credibility involves the composition of the IASB members and the members’ independence, competencies and transparency regarding the due process to draw accounting standards. The due process followed by the IASB to draw up financial statements intends to enhance transparency and to ensure that parties concerned can be involved in the standard setting process and have an opportunity to make their views clear (Burlaud & Colasse, 2011). The due process is published on the IASB’s website in a document entitled “How we consult: Encouraging broad participation in the development of IFRS” signed by Sir David Tweedie (IASB, 2010c:3). See Figure 4.5: IASB Due process to develop below for a schematic illustration of the due process. Apart from publishing the due process and inviting interested parties to participate in the accounting setting process, the IASB also uses advisory bodies to strengthen its procedural legitimacy (IASB, 2012c).
1 INTRODUCTION
1.1 Introduction
1.2 Background
1.3 Research Problem
1.4 Research Objective and Research Questions
1.5 Research Design
1.6 Assumptions
1.7 Scope, Delineation and Limitation
1.8 Contributions
1.9 Publications from this study
1.10 The Structure of the Research Project
2 HISTORY OF THE DEVELOPMENT OF THE CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING (CFfFR)
2.1 Introduction
2.2 Pre-capitalist Period, 4000 B.C. to 1000 A.D.
2.3 Commercial Capitalism, 1000 to 1760
2.4 Industrial Capitalism, 1760 to 1830
2.5 Financial Capitalism: Return on Capital Invested 1830 to 1900
2.6 Financial Capitalism: Corporate Capitalism and Verifiability, 1901 to 1938
2.7 Financial Capitalism: Professional Bodies’ Search for Principles, 1938 to 1973
2.8 Financial Capitalism: Global Capital Markets: 1973 to the Present
2.9 Summary of the Historical Development of the IASB’s CFfFR
2.10 A Global CFfFR: A Wicket Problem
2.11 Conclusion
3 RESEARCH METHODOLOGY AND RESEARCH PLAN
3.1 Introduction
3.2 Research Problem and Research Questions
3.3 Philosophy: Ontological View of Reality and Axiological Implication
3.4 Research Approaches
3.5 Methodological Choice
3.6 Research Strategy
3.7 Time Horizon
3.8 Research Techniques and Procedures
3.9 Knowledge Contribution and Verification
3.10 Limitations
3.11 Conclusion
4 REQUIREMENTS OF A GLOBAL CFfFR
4.1 Introduction
4.2 Data Collection Method: Systematic Review Protocol
PART A: DATA COLLECTION PROCESS
4.3 The Need for a Conceptual Framework in a Global Economy
4.4 The Purpose of a Conceptual Framework for Financial Reporting
4.5 The Objective of a Conceptual Framework in Accounting
PART B: DATA COLLECTED – ABSTRACTION OF REQUIREMENTS AND DEFINITION
4.6 Characteristics and Requirements of a Global CFfFR
4.7 A Proposed Definition for a Global CFfFR
4.8 Evaluation of the CFfFR Against the Requirements of a Global CFfFR
4.9 Conclusion
5 THE ROLE OF A GLOBAL CFfFR AS A MODEL
5.1 Introduction
5.2 Models in Philosophy of Science
5.3 Models in Computing
5.4 Idealised Assumptions
5.5 Knowledge Contribution
5.6 Conclusion
6 ONTOLOGIES AND FINANCIAL REPORTING
6.1 Introduction
6.2 Ontology in Philosophy
6.3 Ontologies: Computing and Financial Reporting
6.4 Formal Domain Ontologies and Financial Reporting
6.5 Idealised Assumptions
6.6 Knowledge Contribution
6.7 Conclusion
7 A FORMAL DOMAIN ONTOLOGY OF THE CFfFR
7.1 Introduction
7.2 Guidelines to Build an Ontology
7.3 Building the CFfFR Ontology: Version 1 – Iteration 1
7.4 Building the Ontology: Version 1 – Iteration 2
7.5 Building the Ontology: Version 1 – Iteration 3
7.6 Building the Ontology: Version 2 – Iteration 4
7.7 Verification
7.8 Conclusion
8 FINDINGS AND EVALUATION
8.1 The Research Problem and Research Questions Answered
8.2 Sub-Research Question 1 (SRQ 1)
8.3 Sub-Research Question 2 (SRQ 2)
8.4 Sub-Research Question 3 (SRQ 3) and the Main RQ
9 CONTRIBUTION
9.1 Introduction
9.2 Methodological Perspective
9.3 Technological Perspective
9.4 Interdisciplinary Perspective
9.5 Accounting Perspective
9.6 Conclusion
10 CONCLUSION
10.1 Introduction
10.2 Problem Identification, Motivation and Scope
10.3 Summary of Findings
10.4 Reflection
10.5 Limitations of the Research
10.6 Areas for Further Research
10.7 Conclusion
11 REFERENCES
