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International Accounting Standards Board

This document is provided as a convenience to observers at IASB meetings, to assist them in following the Boards discussion. It does not represent an official position of the IASB. Board positions are set out in Standards. These notes are based on the staff papers prepared for the IASB. Paragraph numbers correspond to paragraph numbers used in the IASB papers. However, because these notes are less detailed, some paragraph numbers are not used.

INFORMATION FOR OBSERVERS IASB Meeting: Project: 13 December 2005, London (Agenda Paper 2) Conceptual Framework Qualitative Characteristics 6: Costs and Benefits



This paper continues consideration of the qualitative characteristics of accounting information. In May and June, the Boards considered the definitions of the qualitative characteristics of relevance, faithful representation, understandability, and comparability, as well as whether other candidates for qualitative characteristics needed to be considered. The Boards also considered the role of materiality. In July, September, and October, the Boards considered relationships between those qualitative characteristics identified in May and June. This paper examines the one remaining topic being considered under qualitative characteristics, whether the benefits of an accounting standard justify the costs involved.


The cross-cutting issue addressed in this paper is: QC13: Cost/benefitdo the qualitative characteristics, especially the cost-benefit

balance, differ for different entities, e.g., large/small, listed/unlisted, widely dispersed ownership vs. closely held?

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IASB/FASB December 2005 Qualitative CharacteristicsCosts and Benefits 3. This paper focuses primarily on one aspect of that cross cutting issueassessing for all entities whether the benefits justify the costs involvedrather than on the differences between different entities, which was the subject of a separate paper discussed at the October 2005 joint meeting. 4. This paper begins with the existing discussions of this matter in the current IASB and FASB frameworks, summarizes various research and recent developments concerning cost-benefit analysis in financial reporting, and concludes with a recommendation. Also included, for your convenience, is an Appendix 1 summarizing Board decisions to date. Appendix 2 [omitted from observer notes] contains excerpts from a 1991 FASB publication, Benefits, Costs, and Consequences of Accounting Standards. 5. The staff requests the Boards approval to proceed to draft material for an Exposure Draft based on the discussion in this paper. Cost-Benefit in the Current Frameworks 6. The IASB Framework says: 44. The balance between benefit and cost is a pervasive constraint rather than a qualitative characteristic. The benefits derived from information should exceed the cost of providing it. The evaluation of benefits and costs is, however, substantially a judgmental process. Furthermore, the costs do not necessarily fall on those users who enjoy the benefits. Benefits may also be enjoyed by users other than those for whom the information is prepared; for example, the provision of further information to lenders may reduce the borrowing costs of an enterprise. For these reasons, it is difficult to apply a cost-benefit test in any particular case. Nevertheless, standard-setters in particular, as well as the preparers and users of financial statements, should be aware of this constraint. 7. That paragraph makes the following points: 8. Cost-benefit is a constraint, not a qualitative characteristic. Costs often fall on parties that do not benefit. The evaluation is judgmental, and difficult to apply.

FASB Concepts Statement 2 says that, and quite a bit more. The entire discussion is reproduced below, footnotes included, with emphasis added on certain points: Hierarchy of Accounting Qualities: Pervasive Constraint: Benefits > Cost

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IASB/FASB December 2005 Qualitative CharacteristicsCosts and Benefits 134. Unless the benefits to be derived from a commodity or service exceed the costs associated with it, it will not be sought after. When a decision to acquire a commodity is being considered, the prospective buyer will compare the costs of acquisition and maintenance with the benefits of owning the commodity. Once the purchase has been made, the owner must decide continually, from day to daywhether the opportunity cost of ownership, the sacrifice of the sale price that cannot be realized so long as ownership continues, is less than the benefits of continued ownership. Thus, both before and after acquisition, costs and benefits must be compared, though the comparison takes a somewhat different form according to whether the acquisition has or has not been consummated. 135. Financial information is unlike other commodities in certain important respects. While, in general, it will not be desired unless its benefits exceed its costs, what makes it different from other commodities, or at least from those that are traded in the marketplace, is that whereas those other commodities are private goods, to be enjoyed only by the buyer and those with whom the buyer chooses to share them, the benefits of information cannot always be confined to those who pay for it. If the whole government and private system by which the flow of financial information is regulated could now be dismantled, if information could be traded between buyers and sellers like other commodities and could be kept from those who did not pay for it, and if consumers of information were willing to rely on their own inquiries, the balance of costs and benefits could be left to the market. But in the real world the market for information is less complete than most other markets, and a standard-setting authority must concern itself with the perceived costs and benefits of the standards it setscosts and benefits to both users and preparers of such information, to others, like auditors, who are also concerned with it, and to anyone else in society who may be affected. 136. Most of the costs of providing financial information fall initially on the preparers, while the benefits are reaped by both preparers and users. Ultimately, the costs and benefits are diffused quite widely. The costs are mostly passed on to the users of information and to the consumers of goods and services. The benefits also are presumably passed on to consumers by assuring a steady supply of goods and services and more efficient functioning of the marketplace. But, even if the costs and benefits are not traced beyond the preparers and users of information, to say anything precise about their incidence is difficult. There are costs of using information as well as of preparing it; and much published information would be compiled for the preparer's own use even if providing it to stockholders and others were not required. The preparer enjoys other benefits also, such as improved access to capital markets, favorable impact on the enterprise's public relations, and so on. 137. The costs of providing information are of several kinds, including costs of collecting and processing the information, costs of audit if it is subject to audit, costs of disseminating it to those who must receive it, costs associated with the dangers of litigation, and in some instances costs of disclosure in the form of a loss of competitive advantages vis-a-vis trade competitors, labor unions (with a consequent effect on wage demands), or foreign enterprises.

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IASB/FASB December 2005 Qualitative CharacteristicsCosts and Benefits The costs to the users of information, over and above those costs that preparers pass on to them, are mainly the costs of analysis and interpretation and may include costs of rejecting information that is redundant, for the diagnosis of redundancy is not without its cost. 138. Society needs information to help allocate resources efficiently, but the benefit to any individual or company from that source is not measurable. Nor is the spur to efficiency that comes from making managers account to stockholders capable of evaluation, either at the level of the enterprise or the economy. It is impossible to imagine a highly developed economy without most of the financial information that it now generates and, for the most part, consumes; yet it is also impossible to place a value on that information. 139. From the point of view of society, the loss of competitive advantage that is said to result from some disclosure requirements is clearly in a different category from the other costs involved. Although the loss to one business enterprise may be a gain to another, the Board is aware of and concerned about the economic effects of the possible discouragement of initiative, innovation, and willingness to take risks if a reward to risk taking is denied. That is another cost that is impossible to begin to quantify. 140. The burden of the costs and the incidence of benefits fall quite unevenly throughout the economy, and it has been rightly observed that ". . . the matter of establishing disclosure requirements becomes not only a matter of judgment but also a complex balancing of many factors so that all costs and benefits receive the consideration they merit. For example, a simple rule that any information useful in making investment decisions should be disclosed fails as completely as a rule that says disclosure should not be required if competitive disadvantage results."1 The problem is to know how to accomplish that "complex balancing." 141. The Board has watched with sympathetic interest the efforts of the Cost Accounting Standards Board (CASB) to come to grips with the task of comparing the costs and benefits of its standards. The Report of the special group of consultants who were asked by the CASB to examine this matter was submitted on November 13, 1978. The conclusions were quite negative. Our conclusion is that no objective cost benefit calculation in aggregate quantitative terms is possible for CASB standards as a whole or for any of them individually. Reasonable people, with some experience in such matters, acting responsibly in a spirit of compromise, using such reliable information as can be gathered together, will make a "calculation," as they must if anything is to be done. But the calculation will be in ordinal rather than cardinal terms; it will be rough rather than precise; it will always be subject to revision, rather than fixed in stone. The situation is not different from that concerning the merits of many other laws, rules, regulations, and administrative decisions. Nor is our conclusion different from the

R. K. Mautz and William G. May, Financial Disclosure in a Competitive Economy (New York: Financial Executives Research Foundation, 1978), p. 6.

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IASB/FASB December 2005 Qualitative CharacteristicsCosts and Benefits conclusion reached by those concerned with the cost-benefit problem confronting the Paperwork Commission, for example.2 142. As the CASB's consultants point out, the reasons for that negative conclusion can be simply stated. The costs and benefits of a standard are both direct and indirect, immediate and deferred. They may be affected by a change in circumstances not foreseen when the standard was promulgated. There are wide variations in the estimates that different people make about the dollar values involved and the rate of discount to be used in reducing them to a present value. "For these reasons," the consultants conclude, "the merits of any Standard, or of the Standards as a whole, can be decided finally only by judgments that are largely subjective. They cannot be decided by scientific test." 143. Despite the difficulties, the Board does not conclude that it should turn its back on the matter, for there are some things that it can do to safeguard the cost-effectiveness of its standards. Before a decision is made to develop a standard, the Board needs to satisfy itself that the matter to be ruled on represents a significant problem and that a standard that is promulgated will not impose costs on the many for the benefit of a few. If the proposal passes that first test, a second test may subsequently be useful. There are usually alternative ways of handling an issue. Is one of them less costly and only slightly less effective? Even if absolute magnitudes cannot be attached to costs and benefits, a comparison between alternatives may yet be possible and useful. 144. Though it is unlikely that significantly improved means of measuring benefits will become available in the foreseeable future, it seems possible that better ways of quantifying the incremental costs of regulations of all kinds may gradually be developed, and the Board will watch any such developments carefully to see whether they can be applied to financial accounting standards. Even if that hope proves to be a vain one, however, the Board cannot cease to be concerned about the cost-effectiveness of its standards. To do so would be a dereliction of its duty and a disservice to its constituents. 9. Those 11 paragraphs from the FASB framework make the following points: Cost-benefit is a pervasive constraint, not a qualitative characteristic [same as IASB Frameworks first point]. The costs of providing financial information fall initially on the preparers, while the benefits are reaped by both preparers and users [much the same as IASB Frameworks second point]. Financial information is unlike other commodities in not being a private good, to be enjoyed only by the buyer and those with whom the buyer chooses to share them.

Robert N. Anthony et al, "Report to the Cost Accounting Standards Board by a Special Group of Consultants to Consider Issues Relating to Comparing Costs with Benefits", (1978), p. 1.

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IASB/FASB December 2005 Qualitative CharacteristicsCosts and Benefits It is impossible to place a value on the financial information used to allocate resources efficiently, the main benefit of financial accounting standards. It is impossible to quantify the cost of the loss of competitive advantage that is said to result from some disclosure requirements. The merits of any standard can be decided finally only by judgments that are largely subjective. They cannot be decided by scientific test. Any calculation will be in ordinal rather than cardinal terms, rough rather than precise, and subject to revision. The situation is not different from that concerning the merits of many other laws, rules, regulations, and administrative decisions. [an expansive version of the third point in the IASB Framework].


The first two points shared by the present frameworks still seem appropriate, and relatively uncontroversial, (although perhaps more emphasis is needed on the costs to users of having to ferret information out from incomplete, obscure, or poorly presented financial statements.) The staff recommends that the first two points be carried over in the converged framework. However, the third shared point needs some reconsideration, as do the other points made in the FASB discussion. The balance of this paper reconsiders those points.

Is Cost-Benefit Analysis Too Difficult to Apply in Standard Setting? 11. Both frameworks say or imply that, for accounting standard setting, rigorous costbenefit analysis is too difficult to apply. They also say that the evaluation of whether the benefits of a financial reporting requirement justify the resulting costs has to be judgmental. They provide some logical arguments for why that should be so, but no proofs. 12. In the basis for conclusions of their standards, both Boards typically mention costbenefit considerations briefly, and judgmentally. The FASB often discusses those considerations explicitly in a separate section. The IASB is less explicit. For example, in recent standards on stock-based compensation: The FASB, in a separate section of its basis for conclusions, said that the value of that incremental improvement to financial reporting and most of the costs to achieve it are subjective and cannot be quantified. It went on to discuss procedures followed in assessing preparers costs, including a field visit program, a survey of commercial software providers, and discussions with valuation experts, plus interviews with nonpublic entities. It concluded that, based on the findings from those procedures, the Statement will sufficiently improve financial reporting to justify the costs it will impose, and went on to enumerate some decisions intended to

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IASB/FASB December 2005 Qualitative CharacteristicsCosts and Benefits mitigate costs of compliance for some preparers. No dollar amounts or relative magnitudes of costs or benefits were given. The IASB did not separately discuss cost-benefit considerations. However, the IASB staff that managed that project recalls that cost-benefit considerationssometimes under the label of practicalityaffected many of the decisions. For example, the Board chose to measure employee services not directly, but indirectly at the fair value of equity instruments granted, adopted the modified grant-date method instead of a units-of-service method that constituents found too complicated, and allowed the use of the relatively simple Black-Scholes-Merton model, all of which reduced costs of compliance for preparers. No dollar amounts or relative magnitudes of costs or benefits were given.


Another procedure that is concerned in part with costs and benefits or practicability, though not necessarily described as such, is field testing of proposed standards. The FASB has conducted at least 14 field tests over the years, the most extensive of which focused on pensions and other post-employment benefits. Veterans of that project recall that the field tests produced some information about the costs of applying the proposed standards and the benefits of the resulting information that the Board found useful in its redeliberations, and the preparers also benefited from their participation by gaining a greater understanding of those obligations and about the trade-offs between dampened volatility and the more complex accounting procedures required to dampen the volatility. However, FASB Board members and staff veterans also recall some field testing on other projects that proved less useful. One reason for that lack of usefuless was that the costs and inconvenience of conducting such tests makes it difficult to recruit voluntary participants, and voluntary tests will suffer from self-selection bias, while neither Board has the power to compel participation. Another reason is that the efforts put into an effort that is only a test rarely are as thorough as when a company must produce real numbers. The staff of this project does not recommend concepts that imply that the Boards should conduct field testing on standards projects.


The Boards often receive comments from constituents suggesting that benefits of proposed standards do justify costsor more often that they do not. Sometimes the Boards explicitly request comments on that matter, but usually not.


Other standard setters have (or have not) considered cost-benefit concepts: Australias Concepts Statement 3 discusses cost-benefit in much the same way as the FASB and IASB. It calls for efforts to assess cost and benefit, but
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IASB/FASB December 2005 Qualitative CharacteristicsCosts and Benefits makes the same points that costs should not exceed benefits, costs and benefits fall on different parties, and assessing them is difficult and ultimately relies on judgment. Canadas Handbook also is similar, saying that the benefits expected to arise from providing information in financial statements should exceed the cost of doing so. In developing accounting standards, the Board weighs the anticipated costs and benefits of its proposals in general terms . . . . and notes the need for judgment. Canada has a differential reporting standard, which also includes cost-benefit tests. New Zealands cost-benefit concepts are virtually identical to those of the IASB. In applying those concepts to the issue of differential reporting for small or private companies, the New Zealanders made the broad assumption that: (a) More benefits are derived from the general purpose financial reports of entities with public accountability because the reports of such entities are likely to have more users. The Japanese discussion paper says that, Accounting standards should be determined based on whether the objectives of financial reporting can be achieved efficiently (paragraph 21) and that a balance must be considered between imposing costs of renegotiating contracts due to changes in accounting standards imposed on the majority of constituencies who are not involved in those contracts and the benefits associated with the changes (paragraph 22). The paper excludes consideration of cost-benefit from the discussion of qualitative characteristics, saying that there is doubt of its significance and that it is self-evident. The UK ASBs Statement of Principles, in contrast, does not discuss costbenefit considerations in its chapter on qualitative characteristics or elsewhere, not even its appendixes comparing it to the IASB Framework and giving background. However, in their FRSSE, the ASB did consider cost-benefit, saying that, among other factors: (g) The standard or requirement provides the least cumbersome method of achieving the desired accounting treatment and/or disclosure for an entity that is not complex. (h) The standard provides guidance that is expected to be widely relevant to the transactions of small entities and is written in terms that can be understood by such businesses. (i) The measurement methods prescribed in the standard are likely to be reasonably practical for small entities. 16. [Paragraph omitted from Observer Notes]

Will More Rigorous Cost-Benefit Analysis Be Forced Upon the Boards? 17. Strong suggestions for just that are coming. One recent example is a June 2005 decision in the U.S. Federal courts on a lawsuit brought by the U.S. Chamber of
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IASB/FASB December 2005 Qualitative CharacteristicsCosts and Benefits Commerce against the SEC. The issue was not a financial reporting matter, but the decision, now final after completion of the appeals process, has a broad effect on all SEC rulemaking conducted under the Administrative Procedures Act (APA). In that case, the courts decided that the SECs claim that it was without a: reliable basis for determining how funds would choose to satisfy the [condition] and therefore it [was] difficult to determine the costs . . . does not excuse the Commission from its statutory obligation to determine as best it can the economic implications of the rule [even in the] face of uncertainty. Uncertainty may limit what the Commission can do, but it does not excuse the Commission from its statutory obligation to do what it can to apprise itself and hence the public and the Congress of the economic consequences of a proposed regulation before it decides whether to adopt the measure. . . . In sum, the Commission violated its obligation under. . . the APA, in failing adequately to consider the costs imposed upon funds. 18. The decision does not address what the SEC needs to do to assess the benefits, or to judge whether benefits justify costs. 19. At least partly as a result of that court case, the SECs cost-benefit analysis on financial reporting matters has become much more extensive. For example, in an April 2005 amendment to its rules on first-time application of international financial reporting standards, the SEC included several pages of detailed paperwork impact analysis that reported estimated hours of work by preparers to apply the standards and the estimated reductions in workload from the accommodations in that amendment. Also, the SEC included in that amendment a less quantitative, but still extensive, cost-benefit analysis that said the following:

V. COST-BENEFIT ANALYSIS In the Proposing Release, the Commission solicited comments on the expected costs and benefits of the proposed amendments to Form 20-F, as well as on any other costs and benefits that could result from the adoption of those proposed amendments. In response, commenters expressed widespread support for the relief that the proposal would provide . . . . However, several commenters maintained that the proposals regarding condensed U.S. GAAP financial information and financial statements for interim periods during the Transition Year would impose costs on 50 foreign private issuers that were unnecessary to achieve the rules purpose and that outweighed the potential benefits to investors. The Commission has modified the final amendments in response to these concerns, thereby eliminating some of the potential costs that issuers may have incurred under the amendments as proposed.

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IASB/FASB December 2005 Qualitative CharacteristicsCosts and Benefits Although none of the commenters provided quantitative data to support their views, the Commission has revised the amendments to Form 20-F in response to the concerns that the commenters expressed. The Commission expects that the adopted amendments to Form 20-F will result in the following benefits and costs.66

It is estimated these amendments will affect approximately 400 foreign private issuers.

A. Expected Benefits The amendments to Form 20-F will benefit foreign private issuers that adopt IFRS, either voluntarily or by mandate, by facilitating their compliance with SEC disclosure requirements as those issuers transition from their Previous GAAP to IFRS. By permitting eligible issuers to provide two rather than three years of financial statements prepared in accordance with IFRS, the amendments will allow those issuers to avoid the retroactive application of accounting standards that may not have been finalized during the earliest reporting period to which they would have to be applied in order to provide financial statements that were in compliance with SEC filing requirements. By eliminating the third year of IFRS financial statements, the accommodation also benefits issuers by aligning SEC requirements with the IFRS 1 standard, which requires only one year of comparative information for the year IFRS is adopted. Through the amendments to Form 20-F, the Commission is eliminating the need for financial statements that would have been required by SEC rules but not otherwise. In years after their Transition Year, when the accommodation will no longer apply, issuers will have available IFRS financial statements for the financial year that they were permitted to exclude under the accommodation. The amendments also will benefit investors in several ways. First, the accommodation will improve the clarity and quality of the financial disclosure that first time adopters of IFRS provide in their SEC filings, thereby enhancing investor understanding. By clarifying the level of information required in the reconciliation of previous GAAP information to IFRS, for example, the amendments will provide investors with a comparable level of reconciliation information between companies that will enable them to understand the material impact of the switch to IFRS on each issuers financial statements. The accommodation also is expected to benefit investors by encouraging the use of IFRS as a high quality body of accounting principles designed to accurately reflect the issuers financial position. By reducing the burden of financial reporting in registration statements filed by first-time adopters of IFRS, the accommodation will encourage those issuers either to enter or to continue their participation in the U.S. capital market, which will further benefit investors by increasing their investment possibilities. These benefits will likely lead to a more efficient allocation of capital. B. Expected Costs The amendments to Form 20-F could result in some costs to issuers relying on the accommodation, although those costs should be minimal as they relate principally to how information required under rules existing prior to these amendments should be presented when based on primary financial statements based on IFRS. One area in which issuers relying on the accommodation may face increased cost relates to the provision of interim financial statements. The Commission has adopted a flexible approach that provides an issuer with a

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IASB/FASB December 2005 Qualitative CharacteristicsCosts and Benefits number of options as to how to comply with the requirements. Although the costs of providing disclosure under the different options may vary, issuers providing interim financial information may select the approach that they deem most suitable to mitigate these potential burdens. The elements of the adopted amendments that apply to all first-time adopters of IFRS will also lead to some increased costs to issuers. The amendments that clarify the level of information that the reconciliation from Previous GAAP to IFRS should contain are not expected to result in increased costs to issuers, because they do not require additional disclosure beyond what first-time adopters of IFRS must provide to comply with IFRS 1. The amendments relating to the use of any exceptions to IFRS will require additional disclosure, and consequently are expected to result in some increased costs for companies that are required to provide that disclosure. [SECURITIES AND EXCHANGE COMMISSION 17 CFR Part 249 [RELEASE NOS. 33-8567; 34-51535; INTERNATIONAL SERIES RELEASE NO. 1285; File No. S7-15-04]] 20. U.S. Federal regulations go further. In Executive Order 12866, issued in 1993 and amended in 2002, the U.S. President ordered every Federal agency to follow a regulatory philosophy under which agencies should assess all costs and benefits of available regulatory alternatives, including the alternative of not regulating. Costs and benefits shall be understood to include both quantifiable measures (to the fullest extent that these can be usefully estimated) and qualitative measures of costs and benefits that are difficult to quantify, but nevertheless essential to consider. Further, in choosing among alternative regulatory approaches, agencies should select those approaches that maximize net benefits. Under the Orders principles of regulation an agency is to propose or adopt a regulation only upon a reasoned determination that the benefits of the intended regulation justify its costs based on the best reasonably obtainable scientific, technical, economic, and other information concerning the need for, and consequences of, the intended regulation. 21. The Administrative Procedures Act and Executive Order 12866 apply to U.S. government agencies, not to the FASB and, of course, not to the IASB. However, the FASBs due process procedures originally were modeled on the Act, and the FASB has often cited those procedures as a basis for the legitimacy of the standards it issues. And the IASBs due process procedures have much in common with the FASBs procedures. The U.S. Chamber of Commerce decision has received considerable attention. Thus, the Boards are likely to hear more about the need to adequately to consider the costs imposed by their proposed standards.

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IASB/FASB December 2005 Qualitative CharacteristicsCosts and Benefits 22. Increasing demand for cost-benefit analysis is not just a United States matter. It is an increasing theme in Europe. For example, in its very detailed 135-page Guide to Cost-Benefit Analysis for Investment Projects, the European Commission includes instructions like this one on page 32: 2.5.3 Phase 3 - From market to accounting prices. The objective of this phase is to determine the column of conversion factors for the transformation of market prices into accounting prices. Project examiners should check if the projects proposer has considered social costs and benefits of the project in addition to financial costs and benefits. Accounting prices, market prices, accrual accounting, and social costs and benefits are all defined in a glossary, and a nearby table provides an Example for the calculation of the standard conversion factor for price distortion of inputs and outputs. 23. The TransAtlantic Business Dialogue is a group of chief executives from American and European companies operating in the United States, Europe, and globally that was originally convened by the U.S. Department of Commerce and the European Commission in Seville in 1995. In its report to the 2005 EU-US Summit, the group endorsed measures to increase confidence in financial reporting including convergence of US standards . . . with IFRS, but also said that governments and regulators should be: 2. Avoiding the creation of new barriers [by] Creat[ing] a template for common impact assessments, including cost-benefit analysis, to evaluate the potential effects of proposed regulations on the transatlantic market. Discuss[ing] science-based approaches to rule making, such as risk assessment and risk management, with a view towards highlighting ex-ante divergences between US and EU regulators across business sectors. (Page 9) 24. 25. 26. [Paragraph omitted from Observer Notes] [Paragraph omitted from Observer Notes] At the U.S. Federal government level, cost-benefit analysis remains a work in progress, as indicated by a Government Accountability Office (GAO) report, issued in July 2005, on its December 2004 workshop on economic performance measures. The workshop was convened to:
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IASB/FASB December 2005 Qualitative CharacteristicsCosts and Benefits Discuss the present state of economic performance measures, such as costbenefit analysis and cost-effectiveness assessment, and identify gaps in their application and the barriers and analytical issues that limit their use in helping assess the performance of federal programs Identify opportunities for the federal government and professional and academic institutions to improve (1) the use of economic performance measures for evaluating federal programs and (2) the general economic principles and guidance on which economic performance analysis is based.

The GAO reported that prospective analyses are often incomplete and inconsistent with general economic principles and are often not useful for comparisons across the government, because they are often based on different assumptions for the same key economic variables. Participants identified gaps in the application of economic performance measures: 1. Economic performance measures are not widely used. 2. Performance of regulations or programs are often not assessed retroactively, even though this information could be useful Participants identified barriers that cause economic performance measures not to be used and several analytical issues that require resolution before consistency and credibility of economic performance measures can be improved: Participants recommended that the Government: 1. Expand the use of economic performance measures, especially for retrospective analysis of existing programs because such analysis could provide lessons on how to improve prospective analysis of proposed programs. 2. Develop a minimum set of general economic principles and abbreviated guidelines 3. Develop one-page summaries and scorecards of economic performance analysis and use expert review to provide procedures and strategies. 4. Standardize some key economic assumptions. 5. Develop an independent and flexible organization to provide guidance and develop standards. Several participants expressed interest in the accounting professions use of standard-setting authorities to develop comprehensive principles and standards (emphasis added). Some participants indicated, however, that professional economics institutions are not designed to govern or monitor the application of economics. 27. Of course nothing is really new under the sun. The FASB has considered benefits and costs with some intensity before this. In 1991, the FASB issued a Special Report, Benefits, Costs, and Consequences of Financial Accounting Standards, which discussed the role of cost-benefit considerations in the FASBs process and the question of whether costs and benefits are measurable, among other topics. That report was the result of a two-year look at costs, benefits, and consequences prompted by criticism that the FASB was not doing enough to weigh those factors in its decision making. Excerpts from that report (now out of print) are attached as

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IASB/FASB December 2005 Qualitative CharacteristicsCosts and Benefits Appendix 2. Excerpted are a discussion of benefits and costs authored by two thenmembers of the FASB staff, Diana Scott and Wayne Upton (pages 119), a 1990 FASAC discussion asking Are Costs-Benefits Measurable? (pages 2135), and another 1990 FASAC discussion about U.S. competitiveness and the benefits of accounting standards (pages 4958). 28. But no good report goes unpunished. A 1994 article by two accounting professors took the authors of that special report, and the FASB, to task for downplaying the cost-benefit constraint. The authors declared that, under the existing conceptual framework the FASB is committed to rejecting a proposed standard if the costs of that standard to all stakeholders equal or exceed the benefit to all stakeholders, even if the implementation of that standard would result in more relevant and reliable financial information. The authors claimed that language commits the Board to consider economic and social consequences as part of the cost-benefit analysis, and that the Board did not do that in Statement 106. (Martens, Stanley and Kevin Stevens, The FASBs Cost/Benefit Constraint in Theory and Practice, Journal of Business Ethics, March 1994, pp 171179.) What Are Our Alternatives? And What Do They Imply for the Framework? A. Do Very Little 29. 30. [Paragraph omitted from Observer Notes] That would call for conceptual language based on what the two frameworks say today. To be brief, following along the lines of the IASB Framework, the converged framework might say something like: A pervasive constraint to financial reporting is that the benefits of required information should justify the costs of providing and using it. [list types of benefits, types of costs3] However, benefits are enjoyed primarily by users of financial reporting information, while costs fall largely on those who prepare that information. Information about benefits, in particular, and about costs is difficult to obtain and likely to be incomplete. For those reasons, it is difficult to apply a cost-benefit test in any particular case. Nevertheless, standardsetters should continue to be concerned about the cost-benefit constraint in conducting their deliberations.
3 Concepts Statement 2, paragraph 37 (reproduced on page 3 of this paper) lists kinds of costs As discussed in the Boards June meetings, the staff plans to use that as a starting point for drafting this section.

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IASB/FASB December 2005 Qualitative CharacteristicsCosts and Benefits B. Commit to Requesting More Information 31. 32. [Paragraph omitted from Observer Notes] The framework could replace the existing language that explains why the Boards cannot do much in the way of cost-benefit analysis with something more like: A pervasive constraint to financial reporting is that the benefits of required information should justify the costs of providing and using it. [list types of benefits, types of costs] Standard-setters should seek information from preparers, users, and other constituents about their expectations concerning the nature and quantity of benefits and costs of proposed standards. While the information about benefits, in particular, and about costs is likely to be incomplete, standard setters should consider in their deliberations the information they can obtain. C. Commit to Conduct Actual Cost-Benefit Analysis 33. A more extensive alternative would be to commit standard setters to more active efforts at cost-benefit analysis. That might be expressed, in concept, with something more like: A pervasive constraint to financial reporting is that the benefits of required information should justify the costs of providing and using it. [list types of benefits, types of costs] Standard setters should analyze benefits and costs of proposed financial reporting requirements, including seeking information from preparers, users, and other constituents about their expectations concerning the nature and quantity of benefits and costs of proposed standards, taking steps to verify the information received from constituents, and conducting research to develop further necessary information. Standards should require financial reporting information only if expected benefits of that information are shown to exceed the expected costs involved in developing and using that information. Staff Recommendation 34. The staff recommends that the discussion of cost-benefit matters be enhanced, with indications that the Boards should solicit information about costsand benefits and find ways to use that information to support judgments that the benefits of a proposed standard justify the costs. Alternative Aessentially unchanged language in the framework indicating that we are standing patwill not be accepted by many of our constituents. 35. How much to enhance it? The staff recommends alternative B, which commits us to always request information and look at it, but not to verifying input from

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IASB/FASB December 2005 Qualitative CharacteristicsCosts and Benefits constituents, developing information in the absence of such input, or hiring staffs of economists who have expertise in cost-benefit analysis. Setting out to do those things, as alternative C would commit the Boards to do, might not be achievable and would certainly extend the time table of every standards project; in other words, the uncertain benefits of choosing alternative C would not justify the substantial costs involved.

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APPENDIX 1 CONCEPTUAL FRAMEWORK OBJECTIVES AND QUALITATIVE CHARACTERISTICS Summary of Tentative Decisions Made in Prior Meetings Sources: FASB Action Alert, IASB Update

OBJECTIVES Objective of Financial Reporting In the two Boards existing frameworks, the overriding objective of financial reporting is to provide information to assist users in making economic decisions, such as making investment, credit, and similar resource allocation decisions.
Liquidity and Solvency

Also, as discussed in the two Boards existing frameworks, the financial statements should provide information to help users assess an entitys liquidity and solvency. However, that objective should be consistent with the overall objective of providing information to a wide range of users. Therefore, the information provided in the financial statements should not be focused upon meeting the information needs of particular types of users that primarily use the financial statements to help them assess an entitys liquidity and solvency.
Stewardship and Accountability

The Board agreed that stewardship and accountability should not be a separate objective of financial reporting by business entities in the converged framework. The Board agreed that the converged framework should clearly describe its meaning of stewardship, which encompasses managements responsibility not only for the custody and safekeeping of assets entrusted to it but also for their efficient and profitable use. As a consequence, the Board agreed that the converged framework should clarify that financial information useful for making investment, credit, and similar resource allocation decisionsthe primary objectiveand would include financial information useful for assessing managements stewardship. Financial Reports The objective is to provide information about the entity to external users, that is, users who lack the power to prescribe the information they require and therefore must rely on the information provided by an entitys management. The entitys management also will be interested in that information. However, because management has the power to obtain the information it requires, any additional information needs of management are beyond the scope of the framework. As with the existing frameworks, the Boards converged framework should be concerned with general purpose financial reports, which focus on the common information needs of users. That does not preclude the Boards from concluding, in a standards-level project, that additional information should be provided to meet the information needs of particular types of users.
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Financial reports should be prepared from the entitys perspective and should aim to provide information to a wide range of users, rather than focus on the information needs of existing common shareholders only. The framework should identify the primary users as present and potential investors and creditors (and their advisors). Later in the project, the Boards will consider whether financial reporting also should provide information to meet the information needs of particular types of users, such as different types of equity participants. Planning Issues for Discussion of Prospective Financial Information The Board agreed that it should continue with the original plan to issue a due process document on objectives and qualitative characteristics (Phase A) before consideration of prospective financial information. That due process document should indicate that the Board will consider the topic of prospective financial information in the later phase on presentation and disclosure, including the boundaries of financial reporting (Phase E). At the October 25, 2005 joint meeting, the Boards decided the initial due process document would be an Exposure Draft. QUALITATIVE CHARACTERISTICS Relevance is an essential qualitative characteristic. To be relevant, information must be capable of making a difference in the economic decisions of users by helping them evaluate the effect of past and present events on future net cash inflows (predictive value) or confirm or correct previous evaluations (confirmatory value), even if it is not now being used. Being capable of making a difference, rather than now being used, is a change from the present IASB Framework; confirmatory rather than feedback value is a change from the present FASB Concepts Statements. Also, the information must be available when the users need it (timeliness). Accounting information has predictive value if users use it, or could use it, to make predictions. Accounting information is not intended in itself as a prediction, nor as synonymous with statistical predictability or persistence. Faithful representation of real-world economic phenomena is an essential qualitative characteristic, which includes capturing the substance of those economic phenomena. Representations are faithfulthere is correspondence or agreement between the accounting measures or descriptions in financial reports and the economic phenomena they purport to representwhen the measures and descriptions are verifiable and the measuring or describing is done in a neutral manner. Therefore, faithful representation requires completeness, not subordinating substance to form, verifiability, and neutrality. Consequently, the common framework should drop the widely misinterpreted term reliability from the qualitative characteristics, replacing it with faithful representation. That replacement is a change from the current IASB and FASB frameworks. The common conceptual framework will need to discuss thoroughly what faithful representation means, and what it does not mean.

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Financial information needs to be verifiable to provide assurance to users that the information faithfully represents what it purports to represent and that the information is free from material error, complete, and neutral. Descriptions and measures that can be directly verified through consensus among observers are preferable to descriptions or measures that can only be indirectly verified. Financial information needs to be neutralfree from bias intended to influence a decision or outcome. To that end, the common conceptual framework should not include conservatism or prudence among the desirable qualitative characteristics of accounting information. However, the framework should note the continuing need to be careful in the face of uncertainty. Although empirical research may provide evidence useful in standard-setting decisions, for example, in assessing trade-offs between desirable qualities, the conceptual framework project should not seek to develop empirical measures of faithful representation or its component qualities. Understandability also is an essential characteristic of decision-useful financial information and should be included in the converged conceptual framework. Understandability is the quality of information that enables users, who have a reasonable knowledge of business and economic activities and accounting and study the information with reasonable diligence, to comprehend the meaning of the information.4 Information is made more understandable by aggregating, classifying, characterizing, and presenting it in a clear and concise manner. Relevant information should not be excluded because it is too complex or difficult for certain users to understand. The converged framework should include presumptions not only about the capabilities of financial statement users but also about the capabilities of financial statement preparers and auditors. Comparability is an important characteristic of decision-useful financial information and should be included in the converged conceptual framework. Comparabilitywhich enables users to identify similarities in and differences between economic phenomenashould be distinguished from consistencythe consistent use of accounting methods. Concerns about comparability or consistency should not preclude reporting information that is of greater relevance, or that more faithfully represents the economic phenomena it purports to represent. If such concerns arise, disclosures can help to compensate for lessened comparability or consistency. Other Characteristics

Other possible characteristics considered, including transparency, credibility, high quality, and internal consistency, do not describe attributes of decision-useful financial information that are distinct from other qualitative characteristics. Thus, they should not be added as separate qualitative characteristics in the converged framework. Transparency, often cited recently as a

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desirable characteristic of financial information, seems to be difficult to define. In current usage, it appears to encompass some of the qualitative characteristics already included in the frameworks. Because it would be redundant, transparency should not be added to the converged framework as a separate qualitative characteristic of decision-useful financial information. Materiality relates not only to relevance, but also to faithful representation. Materiality should be included in the converged framework as a screen or filter to determine whether information is sufficiently significant to influence the decisions of users in the context of the entity, rather than as a qualitative characteristic of decision-useful financial information. Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements. Materiality depends on the nature and amount of the item judged in the particular circumstances of its omission or misstatement. Given the pervasive nature of materiality, it is difficult to consider the concept except as it relates to the qualitative characteristics of relevance and faithful representation. Thus, materiality is a screen or filter used to determine whether information is sufficiently significant to influence the decisions of users in the context of the entity, rather than as a qualitative characteristic of decision-useful financial information. Cost-benefit considerations may limit the information provided by financial reports. The converged framework should include information about the types of costs that should be considered in deciding what financial information should be provided, as well as criteria to help standard setters decide how to take particular types of costs into account. The converged framework should include presumptions not only about the capabilities of financial statement users but also about the responsibilities and capabilities of financial statement preparers and auditors. Relationships between Qualitative Characteristics of Financial Reporting Board members observed that the different qualitative characteristics and their sub-qualities sometimes suggest different answers to standard setting and financial reporting issues. Previously, discussion of such differences has focused on hierarchy (that is, which characteristics prevail over others because they are ranked higher) or bargaining (that is, how much of one quality the Board is willing to "trade-off" to get more of another quality). The Boards agreed that they should consider the characteristics of financial reporting information as steps in a process that results in decision-useful financial reporting. Board members suggested several improvements to the description and illustration of the process proposed by the staff and the staff has refined that process. The Boards decided that the process should be described as a process to be used by standard setters. Do the Objectives and Qualitative Characteristics Need to Differ for Particular Types of Entities? The Boards concluded that there is no need to modify the objectives of financial reporting or qualitative characteristics of decision-useful financial reporting for any types of private-sector entities. The Boards acknowledged that there might be differences in how certain qualitative characteristics are applied.
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