ATTACHMENT - HoTARAC comments
HoTARAC RESPONSE TO IPSASB EXPOSURE DRAFT
'CONCEPTUAL FRAMEWORK FOR GENERAL PURPOSE FINANCIAL REPORTING BY PUBLIC SECTOR ENTITIES: ELEMENTS AND RECOGNITION IN FINANCIAL STATEMENTS'
General comments
HoTARAC notes that significant progress has been made since the release on the Consultation Paper on Phase 2 of the Conceptual Framework. HoTARAC agrees with many of the decisions reached to date, in particular:
· specifying that this Framework section only relates to elements used in GPFSs rather than the broader GPFRs;
· including service potential in the definition of an asset and providing a definition of service potential in the framework;
· associating an asset with an entity through the control concept;
· including non-legal binding obligations in the definition of present obligation;
· covering the definition of elements, their recognition and derecognition; and
· the recognition of various ownership interests that may arise in the public sector context.
However, HoTARAC has significant concerns with a number of the proposals in the current exposure draft, the most important of these being the inclusion of deferred inflows and deferred outflows as elements of financial statements.
HoTARAC is of the view that the proposed approach of defining deferred inflows and outflows would not faithfully represent the economic phenomena and would also mislead users’ understanding of the entity’s financial performance. Further, it appears to mix economic phenomena and accounting devices (‘deferred outflows’ and ‘deferred inflows’) as elements of the financial statements. Additionally no convincing arguments are advanced for their use, in particular whether there is a specific public sector issue to diverge from International Financial Reporting Standards (IFRS). IPSASB needs to be conscious that creating a different definition of elements would likely confuse report readers and is required only when there are significant benefits to do so. The case for the use of deferred inflows and outflows has not been sufficiently demonstrated by the IPSASB.
If IPSASB still consider the need to provide deferred inflows and outflows information essential, the alternative approach presented in AV11 of presentation and disclosure would be preferable to creating separate elements and changing the well understood definition of revenue, expense and net financial position.
HoTARAC reiterates its preference for the IPSASB and International Accounting Standards Board (IASB) to work more closely to achieve convergence of their respective conceptual frameworks and other pronouncements. Even if this would delay progress from an IPSASB perspective, HoTARAC believes such convergence would result in superior long-term outcomes for public sector entities globally. The greater the potential for divergence between pronouncements applicable to government business enterprises (GBEs) (issued by the IASB) and pronouncements applicable to other public sector entities (potentially issued by the IPSASB), the more significant are the practical difficulties in preparing consolidated financial statements for a whole-ofgovernment reporting entity.
HoTARAC recommends that the IPSASB communicate to constituents how and when it will address this obvious tension between standard-setter frameworks under which various public sector entities might operate.
HoTARAC recommends that when developing the conceptual framework, the IPSASB work closely with the IASB and aim to create a uniform conceptual framework. Divergent frameworks will prove especially difficult to apply in countries such as Australia that promote a transaction neutral approach.
HoTARAC believes that having a common conceptual framework for both private and public sectors allows comparability and consistency of financial reporting between the two sectors.
HoTARAC notes the IPSASB's comment on page 6 of the Exposure Draft that "the purpose of the IPSASB's project is not to interpret the application of the IASB Framework to the public sector". However, no reasons have been given as to why the IASB’s conceptual framework is so fundamentally unsuitable for public sector entities, that development of a separate conceptual framework for such entities is warranted. HoTARAC believes the IPSASB's "Process for Reviewing and Modifying IASB Documents" is applicable (at least in part) to the development of a conceptual framework - particularly if alignment (to the degree possible) with IFRS is to remain an objective.
It is also noted that the IASB is currently deliberating on the definition of the elements in the Framework. In HoTARAC’s view, the IPSASB should use the IASB definitions, unless there is a strong justification for departure.
Other comments:
HoTARAC strongly recommends that the size of a transaction should not influence its reporting as suggested in BC7 in relation to executory contracts. Executory contract components should be reported by each party when these meet the element definition and the recognition criteria.
It would be useful if IPSASB could provide an example of a conditional obligation that creates a liability as stated in BC 22.
HoTARAC also supports IPSASB’s conclusions on non-binding obligations stated in BC 31.
Specific matter for Comment 1
1. Do you agree with the definition of an asset? If not, how would you modify it?
HoTARAC does not agree with the proposed IPSASB definition which excludes the concept of ‘future’ economic benefits (which appears to have been extracted and incorporated into the new definition of ‘deferred inflows’ to account for non-exchange transactions). It is not clear if this is intentional to allow for the creation of the additional elements, and whether this would create different interpretations of what constitutes an asset under the current generally accepted accounting principles and the proposed IPSASB framework.
Apart from this separation, HoTARAC generally agrees with the definition of an asset subject to the deliberations by the IASB.
As stated in the response to the earlier Consultation Paper (CP) on Phase 2, HoTARAC regards a past event as indicative of an asset, but not an essential feature of the definition. HoTARAC believes the discussion of paragraph 2.8 relates more to the recognition of an asset, rather than meeting the asset definition. HoTARAC commented in its response to the CP on Phase 2 that it supported applying a power view for recognising assets such as the right to tax, where recognition applies at the point that the government has an enforceable claim on a specific economic resource (for example a taxable event give rise to a claim on a specific taxpayer).
HoTARAC also recommends adding the risks and rewards of ownership as an indicator of control in paragraph 2.7. HoTARAC disagrees with the statement of BC16 that such an approach is incompatible with the control approach. HoTARAC notes that the risks and rewards test is applied to financial instruments under IPSAS 29 Financial Instruments: Recognition and Measurement and leases under IPSAS 13 Leases, without any apparent inconsistency with the control concept.
One jurisdiction perceives “inflow of service potential” as too restrictive to be a useful characteristic of an asset. Rather the existence of service potential is a characteristic of an asset. To illustrate, roads and road furniture created and maintained by the Commissioner of Main Roads provides service potential to the community per the mandate of government to do these things. However, the Commissioner is not the sole beneficiary of the service potential arising from the asset as implied by the use of ‘inflow’ in the exposure draft.
Specific matter for Comment 2
(a) Do you agree with the definition of a liability? If not, how would you modify it?
(b) Do you agree with the description of non-legal binding obligations? If not, how would you modify it?
(a) The definition of liability appears to align with the key characteristics contained in the current IASB/AASB definition of liability. Hence, HoTARAC generally agrees with the definition of a liability, subject to the deliberations by the IASB. However, HoTARAC suggests removing the qualifier ‘little or no realistic alternative to avoid’ from the definition of a liability - this qualifier is part of the definition of a present obligation.
HoTARAC recommends that the statement an entity has ‘little or no realistic alternative to avoid’ should read ‘has no realistic alternative’ or ‘little or no alternative’. HoTARAC is unclear on the reason for using two qualifiers on alternative, as if there was a realistic alternative for avoidance it is unclear how this could be a liability.
Consistent with the views on the definition of an asset, HoTARAC does not consider a past event an essential element of a liability.
Paragraph BC26 states it would not be appropriate to use the term ‘performance obligation’ in the framework, because such obligations are normally conditional and binding agreements vary between jurisdictions. HoTARAC would point out that performance obligations are not necessarily conditional and this would depend on the underlying contractual obligations. HoTARAC also questions the implication this will have for convergence with the impending IFRS on revenue (which will apply across many jurisdictions), being substantially based on the notion of performance obligations. In addition, BC26 canvasses only the singular basis (“performance obligation” approach) for allocation/recognition of revenue. Whilst this is omitted from the body of the draft framework, including in the Basis for Conclusions predisposes users towards the current IASB conceptual approach to revenue recognition in ED 222 [ED/2011/6]. This is preferable for consistency with the IASB revenue frameworks (except with respect to Leases), but fails to acknowledge other bases for proportional recognition of revenue over sales contract involving the transfer of goods or services over the long-term. Prescription of a singular method appears more appropriate in a revenue standard, rather than a framework document.
Paragraph 3.4 states that " An entity cannot be obligated to itself, even where it has publicly communicated an intention to behave in a particular way". Where a department is a division of a government, can one government department be obligated to another government department where both departments are Wholly-Owned Public Sector Entities of the one government? Further to this rhetorical question, one jurisdiction earlier provided feedback on ED 222 noting the inability of non-legal entities to enter into legally binding contracts as evidenced by examples of a body corporate being distinguishable from the relevant department (and the respective legal capacities of those entities). Given the legal capacity of a department and its indivisibility from government, a more robust mechanism than is currently embedded in paragraph 3.4 is necessary.
(b) HoTARAC agrees with the description of non-legal binding obligations and has no further comments.
Specific matter for Comment 3
Do you agree with the definition of revenue? If not, how would you modify it?
HoTARAC does not support the proposed definition of revenue as it excludes deferred inflows. Detailed comments regarding deferred inflows and outflows are provided in response to Specific matter for comment 5.
Consistent with the first sentence of BC 34, HoTARAC supports revenue and expenses being determined by changes in assets and liabilities over the period i.e. asset and liability-led approach due to representational faithfulness and objectivity. This is consistent with the approach used under current Australian GAAP, IPSAS, IFRS and GFS.
HoTARAC believes the concept of representational faithfulness is better aligned when financial statement’s elements are based on objective measure of economic phenomena. This enhances the representation of resources and flows by requiring the reporting entity to assess information about economic events that have transpired during the reporting period.
In addition, HoTARAC recommends adding the concept of economic benefits and service potential as part of the definition of revenue i.e.
“Revenue is:
Increases in inflows of economic benefits and service potential during the current accounting period which increases the net assets of an entity, …………………….”
Specific matter for Comment 4
Do you agree with the definition of expenses? If not, how would you modify it?
HoTARAC does not support the proposed definition of expenses as it excludes deferred outflows. Detailed comments regarding deferred inflows and outflows are provided in response to Specific matter for comment 5.
HoTARAC has similar concerns to those made in response to specific matter for Comment 3.
In addition, HoTARAC recommends adding the concept of economic benefits and service potential as part of the definition of expenses i.e.
‘Expenses are:
Increases in outflows of economic benefits and service potential during the current accounting period which decreases the net assets of an entity, …………………….”
Specific matter for Comment 5 – Deferred Inflows/deferred Outflows
(a) Do you agree with the decision to define deferred inflows and deferred outflows as elements? If not, why not?
(b) If you agree with the decision to define deferred inflows and deferred outflows as elements, do you agree with the:
(i) Decision to restrict those definitions to non-exchange transactions? If not, why not?
(ii) Definitions of deferred inflows and deferred outflows? If not, how would you modify them?
(a) HoTARAC strongly disagrees with the decision to define deferred inflows and deferred outflows as elements. HoTARAC believes that the inclusion of deferred inflows and outflows as elements fundamentally redefines the accounting framework accepted across both the public and private sectors, without sufficient justification. As stated in HoTARAC’s response to the earlier consultation paper, HoTARAC favours the assets and liabilities-led approach and does not support the identification of deferrals, as these would not faithfully represent the economic phenomena.
As the deferred inflow/outflow approach represents a radical departure from the asset and liability led approach used under IFRS and GFS, HoTARAC would have expected further information and conceptual justification based on the specific public sector issue and public sector user needs to be provided on this proposal, given the resulting divergence from IFRS and GFS.
In paragraph BC40 the IPSASB identified and considered four options to present deferred inflows and deferred outflows in financial statements. HoTARAC does not support the two options of broadening the asset and liability definitions to include deferred inflows and deferred outflows or defining deferred inflows and deferred outflows as separate elements. However, HoTARAC would be prepared to support the presentational approach of dealing with deferred inflows and deferred outflows through presentation or note disclosure or other forms of communication. HoTARAC notes that the use of an ‘other comprehensive income’ presentation would promote alignment with both IFRS and, by funnelling valuation adjustments through OCI, other economic flows used in GFS. This approach would meet the IPSASB’s objective to provide additional information on these transactions, if such information is adequately identified as a public sector user need and strengthen the understanding and communication to users of financial statements and hence, meet the objectives of financial reporting.