A science based approach to the conceptual framework for general purpose financial reporting by public sector entities

A Science-Based Approach to the Conceptual Framework for
General Purpose Financial Reporting by Public Sector
Entities
Petri Vehmanen - petri.vehmanen@uta.fi
University of Tampere, Finland

Abstract
The International Public Sector Accounting Standards Board (IPSASB) has recently pub-
lished a Consultation Paper on its Conceptual Framework for General Purpose Financial
Reporting by Public Sector Entities. The author considers that there are problems in the
Consultation Paper, and the aim of this paper is to analyze conceptually four of the problems
in detail. These are:

1. the meaning of the term “conceptual framework” in general purpose financial re-
porting by public sector entities
2. the objectives of financial reporting by public sector entities
3. the scope of financial reporting by public sector entities, and
4. the qualitative characteristics of information included in general purpose finan-
cial reports.
Conclusions are derived on each topic. The meaning of the term “conceptual framework” is
understood as a set of coherent principles and underlying concepts that are formulated to
enhance understanding rather than as a deductive conceptual system for which the truth is
established empirically by applying scientific method. The two objectives of financial
reporting (i.e., accountability and decision-usefulness) in the IPSASB Framework should be
prioritized to cope with the tension that is inevitably between them. The scope of financial re-
porting by public sector entities is wider than that of business entities which has implications
for the concept formation. This should be given additional attention. Finally, the most signifi-
cant result of the paper is its revised system of the qualitative characteristics of information
included in general purpose financial reports.

Keywords: Conceptual framework, scientific method, faithful representation, measurement,
relevance, reliability

Introduction
The International Public Sector Accounting Standards Board (IPSASB) has recently pub-
lished a Consultation Paper (IPSASB CP, 2008) covering the following four areas of its
proposed conceptual framework:
• The Objectives of Financial Reporting
• The Scope of Financial Reporting
• The Qualitative Characteristics of Information Included in General Purpose Financial
Reports (GPFRs), and
• The Reporting Entity.

International Journal of Governmental Financial Management 1

The author considers that there are problems with the Consultation Paper and the aim this
paper is to discuss the four most important problems and to propose some revisions. More
specifically, the following four topics are covered:
1. The meaning of the term “conceptual framework” in the phrase “international
conceptual framework for general purpose financial reporting (briefly, financial
reporting) by public sector entities”;
2. The objectives of financial reporting by public sector entities;
3. The scope of financial reporting by public sector entities; and
4. The qualitative characteristics of information included in general purpose
financial reports (GPFRs).

1. A conceptual framework may have two distinct meanings. Each meaning is
communicated using different concepts and terminologies. The problem with the IPSASB
Framework is that it takes the meaning for the conceptual framework from the one
approach but the concepts and terminology from the other approach. This will result in
misunderstandings. The most harmful of these is the illusion of certainty that the IPSASB
Framework is likely to create.
2. The objectives of financial reporting by public sector entities are seen in the IPSASB
Framework as providing information about the reporting entity useful to users of GPFRs
for two kinds of purposes: accountability purposes and decision-making purposes
(IPSASB CP, 2008, p.8). The problem lies with the breadth (or extensiveness) of these
objectives. Accountability is related with the past, or more specifically, with the control
of the managerial actions taken in the past while decision-usefulness is related with the
future, that is, with the usefulness of information in forecasting relevant outcomes of
future phenomena. There is a clear tension between these two perspectives. Financial
statements report past events but may use valuations based on future costs or revenues;
the choice does to some extent influence their usefulness for, respectively, accountability
or decision making. Hence it is difficult to construct the financial statements of an entity
without giving the priority to one perspective or the other. Thus it should be explicitly
said which perspective is used in preparing these “general purpose” financial statements
and which perspective is then accounted for by supplying additional information. Using
the term “general purpose” is actually hiding the problem and the term is therefore
somewhat misleading.
3. The scope of financial reporting encompasses the provision of financial and non-financial
information about a total of five items including the two that are familiar from the
business environment:
(1) economic resources and claims to those resources (the balance sheet) and
(2) the effect of transactions, other events and activities that change the economic
resources and claims to those resources (the income statement and the statement of cash
flows).
The additional three items are:
(3) the reporting entity’s compliance with relevant legislation or regulation and legally
adopted or approved budgets used to justify the raising of monies from taxpayers and
ratepayers;
(4) the reporting entity’s achievement of its service delivery objectives; and


(5) prospective financial and other information about the reporting entity’s future service
delivery activities and objectives, and the resources necessary to support those activities.
The additional items make the scope of public sector financial reporting larger than that for
private sector business entities and reflect the wider range of potential users of the GPFRs of
public sector entities.
The problem is that the proposed conceptual framework does not sufficiently acknowledge
that this wider scope may have implications for the definition and measurement of some key
concepts, particularly the definition and measurement of an asset. In the context of business
entities in the private sector the objective is to provide financial information about the
reporting entity that is useful to present and potential equity investors, lenders and other
creditors in making decisions in their capacity as capital providers. The context of public sec-
tor entities is more diverse (cf. IASB ED, 2008, p.14 and IPSASB CP, 2008, p.18) thus
requiring further analysis of the definition and measurement of an asset.
4. The qualitative characteristics of information included in GPFRs are defined as the attrib-
utes that make that information useful to users for accountability purposes and for making
various decisions. There are at least three problems concerning these attributes. The first
of them, which is also acknowledged in the Consultation Paper, is that in practice all the
given qualitative characteristics may not be fully achieved, and therefore a balance or
trade-off between certain of them may be necessary (IPSASB CP, 2008, p.31). That, of
course, is true and requires no further comment.
The second problem concerns the derivation of the qualitative characteristics. They are
just enumerated in the Consultation Paper without an explicit attempt to derive them from
the concept of usefulness. To describe the process, the Consultation Paper only explains
that these qualitative characteristics have been “developed” after considering the
qualitative characteristics in the IASB Framework (IASB ED, 2008). Obviously some
“development” has been required. As the Consultation Paper indicates, the qualitative
characteristics of information included in GPFRs must:
(a) respond to the objectives of GPFRs of public sector entities (which are to some extent
different from those of the business entities in the private sector), and
(b) reflect a potentially broader scope of financial information than that which the IASB
has currently identified (IPSASB CP, 2008, p.31).
Despite these deficiencies in the process of “developing” the qualitative characteristics, the
process itself will not be further commented on in this paper. Instead the focus will be on the
outcome, that is, on the qualitative characteristics themselves, wherein the third problem lies.
This is the terminology of the qualitative characteristics and the underlying concepts. The
concept of faithful representation that has been borrowed from the theory of measurement
should be replaced with the more familiar concept of reliability. Relevance and reliability
should be regarded as the two fundamental qualitative characteristics of useful financial
reporting information (cf. IASB ED, 2008, pp.35-38). The concept of verifiability should be
considered subordinate to reliability and given its customary, more restricted scientific
meaning (to be explained later). Moreover, to fill the resulting gap, the new concept of
supportability should be introduced and defined. In addition, all the constraining factors
should be regarded as elements of sufficiency (also to be explained later). Therefore, to
ensure usefulness of the reported information, it should have the fundamental qualitative
characteristics of relevance and reliability (or freedom from error, if preferred) under the


general constraint of sufficiency. These three key concepts are hierarchical (as will be
explained later).
The structure of the paper is as follows. After this introduction there will be a more detailed
discussion on each of the four problems mentioned and introduced in the above numbered
list. The discussions will then be summarized in the concluding remarks after which there
will be the list of references and an appendix where the scientific method is briefly reviewed.

The meaning of an international conceptual framework
The Consultation Paper does not define the phrase “international conceptual framework”, but
it says enough to be able to conclude the intended meaning. The Consultation Paper explains
that the IPSASB Framework will establish the concepts that underpin financial reporting by
public sector entities that adopt the accrual basis of financial accounting (IPSASB CP, 2008,
p.6). Generally speaking this description gives the concept of framework about the same
meaning that, for example, Hendriksen and van Breda (1992, p.22) obviously have in mind
when they define the concept of (accounting) theory:
“Accounting theory has been defined as a coherent set of logical principles that:
1. Provides a better understanding of existing practices to practitioners, investors, managers,
and students.
2. Provides a conceptual framework for evaluating existing accounting practices.
3. Guides the development of new practices and procedures.”
Here the word “theory” refers to an agreed-upon coherent set of logical principles expressed
in specific terms. The same applies to the word “framework”. The principles involved are se-
lected to enhance understanding and thus facilitate communication. Such principles can never
be refuted. There is no empirical evidence that could contradict with them. Therefore, the ac-
ceptance of any such theory is a matter of agreement rather than a matter of truth. This is in
sharp contrast to what may be said about the more rigorous empirical theories. Their accep-
tance is based on the truth which must be established using the so called “scientific method”.
Thus the term “theory” has two distinct meanings. It may be understood as a framework
consisting of a set of coherent principles and underlying concepts that are formulated to en-
hance understanding or it may be understood as a deductive conceptual system for which the
truth is established empirically by applying the scientific method. To elaborate the difference
between these two meanings, let us examine the scientific method and its key concepts.
The meaning of the scientific method is a complex matter because there are so many different
techniques at the practical level. However, at the sufficiently general level one can identify a
pattern in any empirical scientific research that may be called the “scientific method” (see,
e.g., Cohen, 1964, p.79). In the heart of this pattern there is the continuing cycle that is illus-
trated in Figure 1 and discussed further in the Appendix using citations from the literature.
The cycle starts from observable empirical facts (phases 1 and 2). It continues with logical ar-
gumentation using those facts (phase 3) and theories or models (phase 4) to derive statements
that are either theoretical propositions (phase 5a) or empirical propositions (i.e., hypotheses)
(phase 5b). They offer a link back to observable real-world phenomena (phases 6 and 7). This
link is crucial in the proper verification of empirical theories.


5a. OUTPUTS
Theoretical proposi-
tions that cannot be
4. EMPIRICAL THEORY directly verified
3. INPUTS
The construction or revision
The first link
of the theory and the deri-
to observation
vation of propositions 5b. OUTPUTS
Propositions that claim
something about the
observable world

9a. CONFIRMATION Agreement
The theory gains support
(but is not proven true)
8. VERIFICATION
Derived propositions
are compared with
measurements
9b. REFUTATION
The theory is proved false
(or the test setting
inadequate) Disagreement

10. REVISIONS
Improvements are
to be continued
indefinitely
2. OBSERVATION 7. OBSERVATION
Measurement refers to Measurement refers to
quantitative observation quantitative observation

1. REAL-WORLD PHENOMENA, 6. REAL-WORLD PHENOMENA,
i.e., empirical facts about the reality i.e., empirical facts about the reality
under study (experience) under study (experience)

Figure 1: The continuing cycle of scientific method


Verification (phase 8) connects theoretical thinking back to observable phenomena. It pro-
vides the observer with empirical evidence that may or may not support the proposed theory.
When the facts and hypotheses agree (phase 9a), the theory is said to be confirmed. It has
gained empirical support. This does not mean, however, that it has been logically proven true
because it is always possible that the very same empirical propositions could have been de-
rived from some competing but different theory. When the facts and hypotheses disagree
(phase 9b), the theory together with the test setting is said to be refuted (or “falsified”). It has
been logically proven that something is wrong in the sense that positive results were not dis-
covered and therefore revisions are needed (phase 10). This process continues indefinitely.
Regarding the implications of the scientific method, a few points are of particular importance.
First, scientific method consists of an endless cycle, where one starts from empirical observa-
tion and ends in empirical observation. Second, from this it follows that the concept of meas-
urement must be inextricably linked to empirical observation. Third, the process of verifica-
tion cannot be properly carried out without true measurements (see phases 8, 9a, and 9b in
Figure 1). Fourth, any attempt to verify without true measurements will lead to speculative
information that does not meet the requirements of empirical science.
Thus it is concluded that the IPSASB Framework is not proposed as an application of the
scientific method. The Framework is not an empirical theory that might be refuted by
appropriate empirical evidence. Therefore it is misleading to adopt terms from the scientific
method but not their meaning. Where scientific terms are being used their accepted meaning
in scientific literature should also be accepted. To follow this principle the qualitative charac-
teristics proposed in the Consultation Paper (IPSASB CP, 2008, pp.31-39) should be modi-
fied. The details will be discussed in the section preceding the concluding remarks.

The objectives of financial reporting by public sector entities
The Consultation Paper (IPSASB CP, 2008, p.18) recognizes that the objectives of financial
reporting are at the core of the Framework and that financial reporting is not an end in itself.
The ultimate purpose is to provide information useful to users of GPFRs which means that
the document should specify (a) who the users are and (b) what kind of information the users
are assumed to require.
(a) The Consultation Paper (IPSASB CP, 2008, p.18) gives a long list of potential users
including taxpayers, citizens and other recipients of services from government as well as the
legislature and oversight bodies. Users such as these are not given as users of general purpose
financial reports by business entities in the private sector. For these reports the list of users is
much shorter consisting typically only of equity investors, lenders and other creditors. More
precisely, the objective of the reports by business entities in the private sector is to provide
financial information about the reporting entity that is useful to present and potential equity
investors, lenders and other creditors in making decisions in their capacity as capital
providers (IASB ED, 2008, p.14).
It is obvious therefore that the number of different users of GPFRs by entities in the public
sector is far greater than the number of different users in the private sector. What is not so ob-
vious, however, is whether this fact has any impact on the kind of information that will be re-
quired by the users. That is, the number of different users of GPFRs would not be so impor-
tant if different users found the same kind of information useful. Is this really the case?
(b) From the perspective of how information should be classified in terms of its usefulness to
users the Consultation Paper identifies two categories of information. The first one consists of


information that is useful for accountability purposes, and the second one consists of
information that is useful for decision making purposes, or more specifically, in making
resource allocation, political and social decisions (IPSASB CP, 2008, p.8).
Two points should be noted. First, it was recognized long ago, in the accounting literature
about private sector business entities, that an accounting theory or framework developed
under the accountability view differs in many respects from a theory based on the decision-
oriented view (e.g., Ijiri, 1975, pp.ix-xi). For example, while the decision-oriented view
emphasizes the usefulness of information to decisions, the accountability view emphasizes
the plausibility to evaluate the past performance of management on the basis of the ac-
counting system as a whole, or while the decision-oriented view emphasizes unbiased infor-
mation for decision making, the accountability view emphasizes such designs of accounting
systems that make it difficult or impossible to produce biased information at all. It is evident
that the potential benefits involved cannot be simultaneously maximized in a single account-
ing system, and therefore one view or the other must be given the priority. This, however, has
not been done in the Consultation Paper. The issue has not even been discussed.
Second, there are many kinds of decisions and many kinds of information need. The Con-
sultation Paper (IPSASB CP, 2008, p.20) claims that some of these needs are similar for en-
tities in the private sector and entities in the public sector. To some extent this claim is proba-
bly true but in general the decision-making model for investors in the public sector is not as
straightforward as it is in the private sector. In the latter the risk-adjusted return on in-
vestment is the overriding criterion (see, e.g., Ross and others, 2002, chapters 10 and 12).
Potential investors in the private sector are typically seen to focus almost exclusively on the
forecast future cash flows and the risk involved.
This model of how investors are assumed to behave in the private sector has been so influen-
tial that it has even effected the definition of an asset which is now typically defined in terms
of “future economic benefits” that “are expected to flow to the entity” (IASB Framework,
par. 49(a)). What is important here is that eventually all the future economic benefits are
assumed to flow to the entity in the form of cash and cash equivalents. The IASB Framework
(par. 53) formulates this as follows: “The future economic benefit embodied in an asset is the
potential to contribute, directly or indirectly, to the flow of cash and cash equivalents to the
entity.”
Are these definitions also appropriate in the conditions where entities operate in the public
sector where the major function is service delivery which by its nature is not expressed in
monetary terms? The answer must be “no”, and this is also acknowledged in the definition of
an asset in IPSAS 1 (paragraph 7) which defines assets somewhat differently as “resources
controlled by an entity as a result of past events and from which future economic benefits or
service potential [emphasis added] are expected to flow to the entity”.
However, the mere addition of the phrase “service potential” into the definition of an asset
does not eliminate the fundamental problem of having assets so closely tied to the future cash
flows. The problem is only transferred from the definition of an asset to its measurement.
This is also evident in IPSAS 1 (paragraph 11), which explains that “assets that are used to
deliver goods and services in accordance with an entity’s objectives but which do not directly
[emphasis added] generate net cash inflows are often described as embodying service
potential.” Does this mean that eventually service potential, too, will generate cash inflows in
terms of which the measurement of service potential should be made? At any rate it is
obvious that in financial statements service potential cannot be reported in its “natural units


of measurement”, for example, in the number of books in a library or in the number of
students educated in an elementary school. Instead, what is typically looked for in the
measurement of service potential is some indirect monetary measure of its value. In Ijiri’s
(1975, p.74) words non-basic resources must be measured in terms of the some basic resource
which is typically cash in any modern economy. This brings the focus back to cash flows.
Whether they are anticipated future cash inflows as indicated in the definition by the IASB
or, for example, current or past outflows is a question that should be further discussed.
To summarize, the objectives of financial reporting by business entities in the private sector
are very closely tied to the forecast future cash flows and the related risk while the objectives
of financial reporting by entities in the public sector are more diverse. This is likely to have
two implications. First, as the Consultation Paper acknowledges, the scope of financial re-
porting by entities in the public sector must be wider than that of business entities in the pri-
vate sector. Second, and this is not acknowledged in the Consultation Paper, for entities in the
public sector the definition and measurement of the key concepts such as economic resources
and claims to those resources may have to be distinguished even more clearly from those for
entities in the private sector. That is, it may be questioned whether it is informative at all to
talk about resources (and consequently assets) in terms of direct or even indirect forecast
future cash flows. It may be preferable to replace these output-based (i.e., benefit-based) defi-
nitions with input-based (i.e., sacrifice-based) definitions where assets would be defined in
terms of unexpired costs. The attribute “unexpired” means that there are future benefits being
expected but the amounts may be unknown or difficult to specify to the extent that is prefer-
able to define and measure the concept of asset in terms of incurred costs rather than expected
future economic benefits or service potential.

The scope of financial reporting by public sector entities
For public sector entities the scope of financial reporting encompasses the provision of finan-
cial and non-financial information about the total of five items (see the third topic in the
introduction). The first one is related to the balance sheet (economic resources and claims to
those resources). The second one is concerned with the income statement and the statement
of cash flows (the effect of transactions, other events and activities that change the economic
resources of the reporting entity and claims to those resources during the reporting period,
including cash inflows and outflows and financial performance). The last three items widen
this traditional scope of financial reporting. They consist of the reporting entity’s compliance
with relevant legislation, the reporting entity’s achievement of its service delivery objectives,
and prospective financial and other information about the reporting entity’s delivery activities
and objectives as well as the resources necessary to support those activities.
Defined in this way the scope is much wider than that of financial reporting for business enti-
ties in the private sector. This is to be expected since it reflects the wider range of potential
users of GPFRs of public sector entities. There is a problem, however, because the proposed
framework does not acknowledge that the wider scope may have implications to the defini-
tion and measurement of some key concepts. For example, as indicated above, the concept of
economic resource and consequently the concept of asset may have to be reconsidered. What
is relevant for an asset in the conditions of business entities in the private sector where the
objective is to provide financial information about the reporting entity that is useful to present
and potential equity investors, lenders and other creditors in making decisions in their capac-
ity as capital providers may not be relevant in the conditions where public sector entities are
operating (cf. IASB ED, 2008, p.14 and IPSASB CP, 2008, p.18).


This problem is closely related to the above concern about the tension between the two major
kinds of accounting systems, that is, systems that are designed to support accountability (and
control) and systems that are designed to support various kinds of decisions. It was claimed
that both kinds of systems may have their benefits but the benefits cannot be simultaneously
maximized in a single accounting system, and therefore one approach or the other must be
given the priority. If this is accepted then one should stop calling these financial statements
“general purpose” financial statements. They would simply be financial statements based on
selected premises. Only financial reporting that also consists of supplementary information
could be labeled as being designed for general purposes.
For entities in the public sector, it may be argued that the priority should be given to the ac-
countability purposes. Assets (being economic resources) and liabilities (being claims to
those resources) should then be defined keeping this priority in mind. Moreover, the
objectives should also be slightly modified to reflect the priority. The formulation could be as
follows:

The objectives of financial reporting by public sector entities are to provide information
in the form of financial statements and supplementary information about the reporting
entity useful to users of this information for: (a) accountability purposes; and (b) mak-
ing resource allocation, political and social decisions. The balance sheet and the income
statement are to be constructed giving priority to the accountability perspective.
What has been said above does not necessarily change the scope of financial reporting. The
scope only establishes the boundary around the transactions, other events, and activities that
may be reported in GPFRs (IPSASB CP, 2008, p.6). It is the implications of the wider scope
of financial reporting by public sector entities that should be acknowledged in one way or the
other. Currently there are no signs of such implications being recognized.

The qualitative characteristics of information included in GPFRs
The qualitative characteristics of information included in GPFRs are defined as the attributes
that make that information useful to users for accountability purposes and for making various
decisions (IPSASB CP, 2008, p.31). Three problems concerning these attributes were men-
tioned in the introduction to this paper (topic 4) but only the third one will be discussed here.
It will be suggested that the terminology of the qualitative characteristics of information and
the underlying concepts should be modified and then portrayed hierarchically as illustrated in
Figure 2. In addition, to evaluate whether the information to be disclosed really has the re-
quired qualitative characteristics, their presence should be considered in a process
comparable to that of the scientific method.
These suggestions are likely to raise some concerns. Why should one apply these qualitative
characteristics rather than the ones proposed by the Consultation Paper? And why should the
application follow the proposed process rather than some other pattern? The answer is simple.
The author proposes the qualitative characteristics and the process as a hypothesis believing
that the hypothesis will stand the test in the sense that its application will eventually result in
information more useful to its users than the information obtained by competing procedures,
for example, the Conceptual Framework proposed by the IPSASB. Admittedly no empirical
evidence is given here to support the hypothesis, but according to the scientific method that is
no obstacle to proposing a hypothesis, or as Homans and Curtis (1970, p.23) put it:


“Hypothesis may mean simply a guess, a hunch, an assumption which points to a
possibly fruitful line of work. Hypothesis may mean a statement of uniformity…
Hypothesis, also, may mean a conceptual scheme.”

Thus, as a hypothetically fruitful set of guidelines, the Consultation Paper (IPSASB CP,
2008, p.7 and p.9) identifies the following qualitative characteristics of information included
in GPFRs of public sector entities: relevance, faithful representation, understandability,
timeliness, comparability, and verifiability. Materiality, cost and achieving an appropriate
balance between the qualitative characteristics are then given as pervasive constraints on that
information. Relevance is considered to encompass confirmatory value, predictive value, or
both (IPSASB CP, 2008, p.32). Faithful representation is claimed to be attained when the
depiction of economic or other phenomena is complete, neutral, and free from material error
(page 33). The only indication of a hierarchy is the distinction between the attributes that are
called the qualitative characteristics of information and the attributes that are called the
constraints on that information.
Here the following system of qualitative characteristics is proposed as a competing
hypothesis. To ensure the usefulness of the information in financial reports, it should
have the fundamental qualitative characteristics of (1) relevance and (2) reliability (or
freedom from error) under the general constraint of (3) sufficiency. The two
fundamental qualitative characteristics may be seen to encompass several enhancing
qualitative characteristics (cf. IASB ED, 2008, pp.38-41). For relevance they are (1a)
confirmatory value, (1b) predictive value, (1c) understandability, (1d) timeliness and
(1e) comparability. Similarly for reliability the enhancing qualitative characteristics are
(2a) verifiability and (2b) supportability. The two fundamental qualitative
characteristics of relevance and reliability are not absolute but show in degrees.
Therefore the general constraint of sufficiency must be introduced and adopted. It
consists of the requirement to achieve a balance between the ideal requirement of (3a)
completeness and the following moderating elements: (3b) neutrality, (3c) materiality
and (3d) cost-benefit-reasonableness.
(1) Relevance
The relevance of information is defined in the Consultation Paper as follows (IPSASB CP,
2008, p.32):
“Information is relevant if it is capable of making a difference in achieving the
objectives of financial reporting that is, in the discharge of the entity’s
accountability obligations or in the decisions made by users of GPFRs.”
(1a) Confirmatory value and (1b) Predictive value
The above definition is a good one, particularly because it is so comprehensive. It encom-
passes both confirmatory value and predictive value as properly mentioned in the Consulta-
tion Paper. In addition, it encompasses even more making thus redundant (or at least subordi-
nate) the attributes understandability, timeliness and comparability as proposed in the Con-
sultation Paper.


EVALUATION CRITERIA FOR POTENTIALLY USEFUL INFORMATION

Fundamental RELEVANCE RELIABILITY
Qualitative
Characteristics Is information capable Is information
of making a difference in free from error?
achieving the objectives?

- CONFIRMATORY VALUE
Enhancing - VERIFIABILITY
Qualitative - PREDICTIVE VALUE
Characteristics - SUPPORTABILITY
- UNDERSTANDABILITY

- TIMELINESS

Moderating SUFFICIENCY
Factor
Is there a balance in terms of the selected dimensions?

- COMPLETENESS
Dimensions of
Moderation - NEUTRALITY

- MATERIALITY

- COST-BENEFIT-REASONABLENESS

Is the balance achieved?

No Yes

REVISE DISCLOSE
INFORMATION INFORMATION

Figure 2: The qualitative characteristics of information in GPFRs


(1c) Understandability
The understandability of information (defined on page 35 as the quality of information that
enables users to comprehend its meaning) is redundant to relevance. How could information
be relevant to a person without first being understandable to him or her? In precisely the same
way that understandability is dependent on a person’s education and knowledge, relevance,
too, is dependent on such matters. The Consultation Paper (IPSASB CP, 2008, p.35) explains
that understandability may be enhanced in many ways. For example, comparability is said to
enhance understandability. Precisely in the same way it may be said that understandability
enhances relevance. Therefore, relevance may be said to encompass understandability, that is,
understandability may be considered an enhancing qualitative characteristic of relevance.
(1d) Timeliness
The timeliness of information (defined on page 35 in terms of having information available to
users before it loses its capacity to be useful for accountability and decision-making
purposes) is redundant to relevance for the same reason. No matter how potentially useful a
piece of information may be, this potential will be lost if the piece of information is not
available at the proper point in time. Therefore, the attribute of timeliness is also a distinct
feature of relevance rather than a parallel qualitative characteristic of financial information.
In other words, timeliness, too, may be regarded as an enhancing qualitative characteristic of
relevance.
(1e) Comparability
The comparability of information (defined on page 36 as the quality of information that en-
ables users to identify similarities in, and differences between, two sets of phenomena) is also
redundant. In other words, comparability is encompassed by relevance. This should be
evident if one considers the opposite. How could a piece of information be relevant if there
were no way whatsoever to compare it with any other piece of information? For example, the
piece of information saying that X has the value of 20 per cent is meaningless as long as one
is unable to compare it with something else. Therefore it cannot be relevant, either. The situa-
tion would change essentially, if one learned that the value of X is typically less than a half of
the return on investment in the same conditions. This new piece of information would not
only make the first piece of information comparable to a known variable but it would also
make it highly relevant. Consequently, the attribute of comparability should also be consid-
ered a distinct feature of relevance, that is, an enhancing qualitative characteristic of
relevance, rather than a parallel qualitative characteristic of financial information.
Supplementary discussion
Thus the concept of relevance is even more powerful than the Consultation Paper acknowl-
edges. It does not only encompass confirmatory value and predictive value but also such fea-
tures as understandability, timeliness and comparability. Therefore any piece of information
that (a) has either confirmatory value or predictive value and (b) at the same time is under-
standable, available at the proper time, and comparable to some other interesting pieces of in-
formation, is relevant. And conversely, a piece of information is not relevant even if it poten-
tially has confirmatory value or predictive value but it is not in an understandable form, or it
is not available when needed, or it cannot be compared to anything that is meaningful to the
user.
Besides relevance the Consultation Paper also regards faithful representation as a necessary
qualitative characteristic of useful information in financial reporting. It argues that a piece of


information is a faithful representation of the economic or other phenomenon that it purports
to represent when the depiction of the phenomenon is complete, neutral, and free from
material error (IPSASB CP, 2008, p.33). Moreover, the Consultation Paper implies implicitly
(see, e.g., pages 9, 28 and 29) that prospective information about the future might also serve
as a faithful representation of something.
Such arguments and implications are problematic, however, because they give the term
“faithful representation” a totally new meaning that is very different from its established
meaning in the theory of measurement. There faithful representation is related to quantifica-
tion which must be made so that the functional correspondence between the degrees of the
observable property and the numbers assigned to these degrees become a faithful representa-
tion. The issue of how to create a proper functional correspondence is called the representa-
tion problem (Krantz and others, 1971, Scott & Suppes, 1969, Suppes & Zinnes, 1963), and it
is concerned with the isomorphism between the observable degrees of the given property in
an empirical system and the relational numerical system selected to represent the empirical
system.
This means that the property being faithfully represented for measurement purposes must be
observable. However, the future cannot be observed. Therefore there is no way in practice to
achieve a faithful representation of any future phenomenon. Consequently the term “faithful
representation” should not be used in this new context where empirical observation is not re-
quired. Of course, it cannot be required precisely because faithful representation is purport-
edly extended to concern the future. Since future phenomena cannot be currently observed,
talking about faithful representation of such phenomenon is simply misleading.
(2) Reliability
Instead of faithful representation, it is preferable to use the term “reliability” of information.
Reliability refers to freedom from error and nothing else. It is not necessary to say that reli-
ability refers to freedom from material error, since this would make the definition equal to
one of the qualitative characteristics of faithful representation (IPSASB CP, 2008, p.33). It is
just freedom from error, not materiality of it that should be considered fundamental. Material-
ity is thus only a moderating factor, not a distinct feature of the fundamental qualitative char-
acteristic.
(2a) Verifiability
This raises the question of how reliability may be established. How could one know whether
a piece of information is reliable or not? The best answer is to apply the scientific method as
shown in Figure 1. First, attempt to verify the truth of the given empirical statement by com-
paring it with what may be observed. This process is called verification. A statement is veri-
fiable if it can be verified. Hence it is proposed that verifiability in this sense should be the
first enhancing characteristic of reliability. This is nothing new. The meaning of verifiability
in this sense is essentially equivalent to that of direct verifiability in the IASB Exposure Draft
(2008, p.40).
(2b) Supportability
Verifiability is a desirable qualitative characteristic of information but in many cases this
characteristic is too demanding. Therefore, what is the next step if a piece of information
cannot be verified? The answer might be in the process that is familiar from auditing. It may
be required possible to check the inputs and recalculate the corresponding outputs. Such
checking would not be verification but rather auditing that gives support and credibility to


information. A piece of information is supportable if it is possible for different
knowledgeable and independent observers to reach general consensus that the methods used
in producing the information have been properly applied (cf. IASB ED, 2008, pp.39-40 and
IPSASB CP, 2008, pp.36-37). Consequently, one may say that supportability is the second
enhancing characteristic of reliability. Its meaning is essentially equivalent to that of indirect
verifiability in the IASB Exposure Draft (2008, p.40).
Whether even supportability is to be required before a piece of information may be disclosed
is an open question. It is possible that a piece of information that can neither be verified nor
even properly supported is so relevant that it would be useful to users although its reliability
cannot be independently verified or checked. The IASB Exposure Draft (2008, p.52) gives
management’s intentions as an example of a piece of information that can neither be verified
(directly verified) nor supported (indirectly verified). Yet it may be useful to users.
Relevance and reliability are thus the two fundamental qualitative characteristics of financial
information. That is, if the user had all the relevant information and it was completely reli-
able, he or she would need nothing else. Usefulness of information would be secured. How-
ever, relevance and reliability are not absolute concepts but show in degrees. Therefore, as
the first step, it was above stated what the additional qualitative characteristics are that
enhance these fundamental characteristics. The second step will now be to set limits to
enhancing. The question is: when does a user have enough of relevant information that is
reliable to the required degree? In other words: when is the supplied information sufficient to
the user?
(3) Sufficiency
The concept of sufficiency is a moderating concept that aims at an acceptable balance be-
tween the qualitative characteristics in terms of a few selected dimensions. The dimensions of
moderation are completeness, neutrality, materiality and cost-benefit-reasonableness.
Because it is not practicable to produce and disclose every piece of relevant information with
absolute reliability to all potential users, it must then be asked what is practicable and
sufficient. The answer is briefly discussed in terms of the given four dimensions (see Figure
2).
(3a) Completeness
Completeness establishes the fundamental starting point to disclose all the information that is
relevant. That is, if a piece of information is capable of making a difference in achieving the
objectives of financial reporting, then it should be produced and disclosed. This is an extreme
requirement demanding that not only part of relevant information should be available but all
of it. Without moderation this requirement would result in great practical difficulties but it is
a necessary starting point.
(3b) Neutrality
Neutrality is defined in the Consultation Paper typically as “the absence of bias that is in-
tended to attain a predetermined result or to induce a particular behavior” (IPSASB CP, 2008,
p.33). It continues: “Neutral information is free from bias, so that it faithfully represents the
economic and other phenomena that it purports to represent.” Taken literally this means that
neutrality is actually redundant to the proposed system. If it is taken to mean that one is not
allowed to select or present information so that it favors some particular perspective, say, an


interest group then it is simply redundant to requiring that the set of relevant information to
be disclosed should be complete. If pieces of information were left out that are relevant from
some perspective, then the disclosed set would not be complete. On the other hand, if it is
taken to mean that one is not allowed to present information so that it is excessively cautious
or in some other way biased then it is simply redundant to requiring that the set of relevant
information to be disclosed should be reliable. A biased piece of information can never be the
best estimate in terms of reliability. Therefore, the complete set of relevant and reliable
information is necessarily sufficient for making neutral estimates of the financial conditions
and hence, as a distinct qualitative characteristic, neutrality is redundant.
However, if neutrality is interpreted as a moderating characteristic then it has a role to play.
In this role neutrality is taken to mean that it is sufficient to report information for general
purposes instead of tailoring it for the purposes of any particular interest groups. The “general
purpose” implies that the selection and presentation of financial information are not biased to
serve particularly any specific groups or goals but “neutrally” to all groups that are interested
in the financial information of the entity. In this sense neutrality moderates the requirement of
completeness.
(3c) Materiality
Materiality is regarded as a pervasive constraint in the Consultation Paper (IPSASB CP,
2008, p.38). That is a misleading statement in a way. Rather than being a pervasive constraint
materiality is a pervasive moderating factor. Instead of requiring the complete set of relevant
financial information, it is sufficient to require all the relevant information that is material
with respect to the objectives of financial reporting, that is, serving the discharge of account-
ability by the entity for the reporting period and serving the decisions that users make on the
basis of the entity’s GPFRs prepared for that period (cf. IPSASB CP, 2008, p.37). Similarly,
instead of requiring complete freedom from error in the reporting of relevant financial infor-
mation, it is sufficient to require that all the disclosed information is free from material error.
Therefore, materiality is clearly a dimension of sufficiency (cf. IPSASB CP, 2008, p.38).
The Consultation Paper does not acknowledge that materiality is a moderating factor. This
becomes evident in the discussion on faithful representation which is claimed to be “attained
when the depiction of the phenomenon is complete, neutral, and free from material [emphasis
added] error” (IPSASB CP, 2008, p.33). Faithful representation, or reliability, simply refers
to freedom from error, however, not to freedom from material error, and it is a distinct issue
to consider the extent to which this characteristic should be required. Completeness is thus
the starting point and materiality is the factor that moderates this extreme requirement.
(3d) Cost-benefit-reasonableness
Cost-benefit-reasonableness refers to requiring that the benefits of financial reporting should
justify the costs that it imposes (IPSASB CP, 2008, p.38). From the economic perspective
this requirement is clearly acceptable. However, it is also a moderating requirement. It asserts
that rather than requiring the complete set of relevant information with perfect reliability it is
only economically reasonable to require information for which the related benefits justify the
corresponding cost. This means that for economic reasons less than perfect information may
be sufficient. The principle is simple and clear but it may be difficult to apply. Assessing
whether the benefits of providing information really justify the related cost will typically be
more qualitative than quantitative. The question becomes ambiguous by asking whether one


or more qualitative characteristics should be sacrificed to “some degree” in order to reduce
costs.
Figure 2 summarizes the above discussion on the qualitative characteristics of information in
GPFRs. The evaluation of a potentially useful piece of information starts from asking
whether it has the first fundamental qualitative characteristic of being relevant, that is,
whether it is capable of making a difference in achieving the objectives. If the answer is “no”,
the piece of information is useless and no further analysis is needed. If the answer is “yes”,
one must ask if the piece of information has the second fundamental qualitative characteristic
of being reliable, that is, whether it is free from error. Again, if the answer is “no”, the piece
of information is useless and it should not be disclosed. If the answer is “yes”, then this piece
of relevant information has the proper characteristics and should be disclosed.
This is an ideal picture of the evaluation process. In practice it becomes more complicated be-
cause the fundamental qualitative characteristics of relevance and reliability are not absolute
but are applied in degrees. Therefore, one must introduce enhancing qualitative
characteristics for the both of these fundamental characteristics. For relevance they are
confirmatory value, predictive value, understandability, timeliness and comparability. An
increase in the attainment of any of these characteristics enhances relevance. Similarly, for
reliability the enhancing characteristics are verifiability and supportability. An increase in the
attainment of these characteristics enhances reliability.
Enhancing could be performed without an end. Therefore one must ask what amount of en-
hancing is sufficient. Consequently sufficiency becomes the moderating factor. As such it is
too ambiguous and therefore it must be made more specific by introducing some dimensions
to it. Four dimensions of moderation were proposed: completeness, neutrality, materiality and
cost-benefit-reasonableness. Therefore, sufficiency reduces to asking if there is a balance
between the given qualitative characteristics in terms of the selected dimensions of modera-
tion. Assessing whether the balance is in fact achieved will typically be more qualitative than
quantitative.

Concluding remarks
The conclusions on the four problems identified with the proposed IPSASB Conceptual
Framework for General Purpose Financial Reporting by Public Sector Entities are summa-
rized as follows:
1. The meaning of the term “conceptual framework”. The term “conceptual
framework” may have two distinct meanings using different auxiliary
terminologies. The first problem is that the IPSASB Framework takes the meaning
from the one approach but the terminology from the other. This will result in
misunderstandings. The most harmful of them is the illusion of certainty in the
disclosed information.
2. The extensiveness of the two objectives of the framework, that is, to serve both
accountability purposes and decision-making purposes. Accountability is related
with the past while decision-usefulness is related with the future. There is a clear
tension between these two. It is not practicable to construct the financial
statements of an entity without giving the priority to one objective or the other. It
should be explicitly said which objective is given the priority in preparing the


“general purpose” financial statements and which objective is then accounted for
by supplying additional information.
3. The extensiveness of the scope of the IPSASB Framework. The proposed
framework does not acknowledge that the wider scope may have implications to
the definition and measurement of some key concepts, particularly that of an asset.
What is relevant for an asset in the context of business entities in the private sector
where the objective is to provide financial information about the reporting entity
that is useful to present and potential equity investors, lenders and other creditors
in making decisions in their capacity as capital providers may not be relevant in
the context where public sector entities operate. It may be questioned whether it is
informative at all to talk about assets in terms of direct or even indirect forecast
future cash flows. It may be preferable to replace the output-based (i.e., benefit-
based) definitions with input-based (i.e., sacrifice-based) definitions where assets
would be defined in terms of unexpired costs.
4. The final problem with the IPSASB Framework concerns the proposed qualitative
characteristics. In particular, the terms “faithful representation” and “verifiability”
are misleading in this context. They are both adopted from the scientific method
but they are both given a new meaning, too. These homemade constructs give the
illusion of a scientific approach to producing information that in a closer
examination only turns out to be quasi-scientific (for more details, see, e.g.,
Vehmanen, 2007, pp.152-168). Adopting a quasi-scientific framework would only
raise false expectations regarding the certainty of the reported information.
Therefore it is highly recommended here that one should modify the terminology
of the framework to better match the level of certainty that may be achieved in
financial reporting.
The proposed modifications to the Framework are by no means radical. They only replace the
concept of faithful representation with the concept of reliability, redefine the concept of veri-
fiability, introduce the moderating factor of sufficiency and portray the whole set of qualita-
tive characteristics hierarchically as a dynamic process comparable to that of the scientific
method. However, although the approach is comparable to that of the scientific method, the
difference between the two should be evident: supportability of information is far less than
verifiability in terms of how convincing or confirming the provided evidence is.
What may be achieved in practice at best by applying these qualitative characteristics is a
systematic approach to producing information based on hard facts and general consensus.
What may not be achieved, however, is refutable financial information based on observable
empirical evidence. That would make financial reporting a true empirical science.
References
American Accounting Association, AAA (1971), ‘Report of the Committee on Foundations
of Accounting Measurement’, The Accounting Review, Supplement to Vol. XLVI
Chambers, R. J. (2002), An Accounting Thesaurus, 500 Years of Accounting, Amsterdam,
Pergamon, Elsevier Science
Cohen, M. R. (1964), Reason and Nature: An Essay on the Meaning of Scientific Method,
New York, Free Press
Einstein, A. (1935), The World As I See It, London, Lane & Bodley Head


Goode, W. J. & Hatt, P. K. (1952), Methods in Social Research, New York, McGraw-Hill
Hendriksen, E. S. & van Breda, M. F. (1992), Accounting Theory, Chicago, Irwin
Homans, G. C. & Curtis, C. P. (1970), An Introduction to Pareto, New York, Howard Fertig
IASB Exposure Draft (ED) (2008), An improved Conceptual Framework for Financial
Reporting – Chapter 1, The Objective of Financial Reporting; Chapter 2, Qualitative
Characteristics and Constraints of Decision-useful Financial Reporting Information,
London, IASC Foundation Publications Department (May 2008)

IASB Framework (2009), in IASB, International Financial Reporting Standards (IFRSs),
London, United Kingdom, International Accounting Standards Board
Ijiri, Y. (1975), Theory of Accounting Measurement, Evanston, Illinois, American
Accounting Association, AAA
IPSASB Consultation Paper (CP) (2008), Conceptual Framework for General Purpose
Financial Reporting by Public Sector Entities – The Objectives of Financial
Reporting, The Scope of Financial Reporting, The Qualitative Characteristics of
Information Included in General Purpose Financial Reports, The Reporting Entity,
Toronto, The International Federation of Accountants, IFAC (September 2008)
Krantz, D. H., Luce, R. D., Suppes, P. & Tversky, A. (1971), Foundations of Measurement,
Vol. I, Additive and Polynomial Representations, New York, Academic Press
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Press, Volume II
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Scott, D. & Suppes, P. (1969), ‘A Set of Independent Axioms for Extensive Quantities’,
in P. Suppes (ed.) Studies in the Methodology and Foundations of Science, Dordrecht,
Holland, Reidel
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and E. Galanter (eds.) Handbook of Mathematical Psychology, Vol. I, New York,
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Appendix: A summary of the scientific method
Scientists have regarded the endless cycle illustrated in Figure 1 as the distinctive characteris-
tic of the scientific method. Let us take a few quotations. The first relates to the ultimate goal
of any empirical science. The goal is to produce true empirical knowledge. Therefore the cru-
cial question is: When can one say that empirical knowledge is true? The truth of any empiri-
cal statement is said to depend on how well it corresponds to empirical facts. This important
starting point is expressed quite clearly, for example, by Popper (1966, p.369) (see Chambers,
2002, p.761):


“…an assertion, proposition, statement or belief, is true if, and only if, it
corresponds to the facts.”
It should be emphasized, however, that science and theories in general are not concerned with
isolated empirical facts. This is reflected in the typical definition of a scientific theory as a set
of sentences or statements (see, e.g., AAA, 1971, p.54). The idea of a more comprehensive
correspondence with a variety of empirical facts is also evident in the citation from Einstein
(1935, p.133) emphasizing that all knowledge of real-world phenomena must start from em-
pirical experience and also end in it (see Chambers, 2002, p.753):
“Pure logical thinking cannot yield us any knowledge of the empirical world; all
knowledge of reality starts from experience and ends in it. Propositions arrived at
by purely logical means are completely empty as regards reality.”
Besides emphasizing the importance of empirical experience (that is, “real-world
phenomena” in Figure 1) the above citations also reflect the cyclic pattern of the scientific
method. Even more explicitly, however, the endless continuity of this cycle is formulated by
Homans and Curtis (1970, p.21) (see Cambers, 2002, p.765):
“To reach a theory, science observes certain facts and argues logically therefrom.
The theory is submitted again to facts. The cycle is: observation, theory,
verification, more observation, and so on forever.”
The cyclic and self-correcting pattern of the scientific method is obvious in the above
citation. However, it lacks two specific concepts (measurement and prediction) that relate to
phases 2, 5b, and 7 in Figure 1. To indicate their role, let us quote Walker (1963, p.5), who
includes these concepts in his definition of the scientific method:
“The scientific method (1) postulates a model based on existing experimental
observations or measurements; (2) checks the predictions of this model against
further observations or measurements; (3) adjusts or replaces the model as
required by the new observations or measurements. The third step leads back to
the first step, and the process continues without end.”
These citations show clearly how important empirical observation is for the production of
scientific knowledge (phases 2 and 7 in Figure 1). Of course, logical thinking, too, has a role
to play in this process (phases 4, 5a, and 5b in Figure 1) but it can never replace empirical
observation. Therefore, human opinions, too, are of only little value in producing scientific
knowledge. Empirical facts are far more relevant and crucial. A scientist does not have to
persuade anybody to think as he or she does, nor need a group of scientists reach consensus
on matters being researched. It suffices that the empirical facts and the corresponding
propositions agree. For example, Goode and Hatt (1952, p.7) formulate the very same point
as follows (see Chambers, 2002, p. 754):
“Science is a method of approach to the entire empirical world… It is furthermore
an approach which does not aim at persuasion, at the finding of ultimate truth…”


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