Study with the several resources on Docsity
Earn points by helping other students or get them with a premium plan
Prepare for your exams
Study with the several resources on Docsity
Earn points to download
Earn points by helping other students or get them with a premium plan
Community
Ask the community for help and clear up your study doubts
Discover the best universities in your country according to Docsity users
Free resources
Download our free guides on studying techniques, anxiety management strategies, and thesis advice from Docsity tutors
The paradoxical relationship between uncertainty and accounting, focusing on the balance sheet and income statement. Uncertainty impacts recognition and measurement of assets and liabilities, and the document argues that if accountants get these right, matching will follow. The document also discusses the concept of release from risk of investments in the Conceptual Framework of the Accounting Standards Board of Japan. Assets are classified based on five different levels of matching, and the document proposes that assets should be recognized based on a threshold for uncertainty. The document concludes by suggesting that a balance-sheet approach for recognizing assets and liabilities under uncertainty resolves the tension and changes the way income statement information is presented.
Typology: Slides
1 / 39
This page cannot be seen from the preview
Don't miss anything!
Center for Excellence in Accounting & Security Analysis
Center for Excellence in Accounting & Security Analysis
Center for Excellence in Accounting & Security Analysis
1. Introduction
The Conceptual Framework of the International Accounting Standards Board (Exposure Draft, IASB, 2015; hereafter ‘Framework’), assigns conceptual primacy to the definition of assets (liabilities), expressed in terms of rights (obligations) with respect to economic benefits (Storey and Storey, 1998; Dichev, 2008). The logic of this ‘balance sheet approach’ is that (net) income is determined as a by-product of the recognition and measurement of (net) assets in the balance sheet. Accordingly, while much of the Framework is concerned with the definition, recognition, and measurement of (net) assets, it offers remarkably little conceptual guidance with respect to the income statement. Particularly noteworthy is that, first, the Framework seemingly rejects the long-standing, ‘traditional’ income statement concept of the ‘matching’ of revenues with expenses (Zimmerman and Bloom, 2016) and, second, it offers no conceptual guidance on the income statement, and so is silent on (for example) the distinctions between income (expenses) and gains (losses), and between gross profit and net profit (Barker, 2010).^1
This paper argues that this ‘marginalisation’ of the income statement arises because the concept of uncertainty is insufficiently developed in the Framework, with the effect that the inherent usefulness of the technology of accrual accounting is inadequately captured. Evidence of this conceptual oversight is that the Framework implicitly assumes that its ‘valuation-relevance’ and ‘stewardship’ objectives in the Framework can best be addressed by accrual accounting, yet it does not justify why this is the case. We argue that uncertainty is the key concept that would provide this justification. At present, the Framework’s discussion of uncertainty is mostly in the context of the challenges that it creates for the measurement of assets and liabilities (e.g. paras. 5.15-5.21) – in other words, it is balance-sheet oriented - yet this does not get to the heart of why the concept of uncertainty is so important for accounting.
We argue that the balance-sheet approach can be extended to accommodate the implications of uncertainty for the informational-usefulness of the income statement, as well as the balance sheet, thereby explicitly acknowledging that the usefulness of accruals lies in the articulation between these two statements. We argue that our approach would:
(^1) The IASB stresses that the income statement is not overlooked (BC4.3). It is likely that, in practice, the IASB does think through income and expenses issues in making recognition and measurement decisions with respect to assets and liabilities. Yet such thinking is not formalised conceptually in the Framework with the same logical clarity that is applied to the deductive approach that starts with the formal definitions of assets and liabilities.
enhance the Framework’s conceptualisation of recognition, measurement, and presentation; strengthen the conceptual foundations of individual accounting standards; and define an accounting for income and expenses (including an income statement presentation) that would be guided by the matching concept in providing useful information to investors.
To develop this argument, we accept the ‘top-down’, deductive approach embodied in the Framework, notwithstanding that in practice such as approach is inevitably partial, fluid and, to a degree, grounded in convention (Dopuch and Sunder, 1980; Macve, 1997, 2010 and 2015; Bromwich et al., 2010); in short, we take as given that the Framework forms part of the modus operandi of the IASB, and our conceptual analysis is conducted within that frame.
We structure our argument as follows. In Section 2, we note that a striking feature of the Framework is its rejection of the matching concept, notwithstanding the central role that matching has traditionally played in accruals accounting. We then note, in Section 3, that the Framework actually has very little to say about accruals, and in particular about why the technology of accrual accounting is presumed to provide useful information to investors. In Section 4, we argue that the concept of uncertainty is critical in making sense of these observations from Sections 2 and 3. This is because conditions of uncertainty render both the balance sheet and the income statement ‘incomplete’, yet complementary, with respect to the IASB’s objective of providing decision-useful information to investors. In short, we argue that the challenge caused by uncertainty calls for the design of an accrual accounting system that adopts both a balance-sheet and an income-statement perspective, and that this demands consideration of the matching concept. Such a conclusion appears to stand in contrast with the Framework’s balance- sheet approach, which we explore in Section 5.
In line with this approach, the Framework explicitly addresses uncertainty in the context of balance-sheet recognition and measurement only. We argue, however, that the Framework also implicitly incorporates uncertainty into its definition of (net) assets, and that this goes a considerable way towards meeting the informational needs of investors, especially in the case of revenue recognition. Given, however, that this incorporation of uncertainty is in effect ‘subconscious’ within the Framework, it is perhaps not surprising that its implications are not fully realised. In Section 6, we therefore propose a ‘conscious’ extension, which employs additional balance-sheet recognition criteria that take into consideration the articulating income statement. At heart, the approach can be viewed as
common with subsequent generations, Edwards, Bell and Johnson (1979, p.11) simply took as given the centrality of the matching concept: “In order to measure the success or failure of business activities, utilizing the criterion of profit, accountants have adopted the concept of matching efforts with accomplishments.”
Matching has an intuitive appeal, with natural linkages to other ‘traditional’ concepts in accounting. It is arguably the purpose of accrual accounting, whereby (for example) accruing receivables, and capitalizing and expensing outflows, enables the matching of income to expenses in determining periodic performance. In this regard, matching lends itself to historical cost measurement, because it can be understood as allocating incurred costs to recognized revenues. And by thus enabling the periodic measurement of value- added from trading in input (supplier) and output (customer) markets, matching is also clearly aligned with the concept of earnings, and of valuation by means of ‘earnings power’. In addition, there is a more subtle, yet also more powerful, intuitive appeal for the matching concept. Ijiri (1975) identifies the ‘exchanges’ concept as a fundamental strength of the double-entry accounting system, whereby the simultaneous recognition of both benefit and sacrifice reveals differences in economic value in the operation of the market economy. Double-entry is more than just an identity; it is a mechanism for the role of markets in conveying information, a role it fills through the matching process by associating the amounts that counterparties give up in exchange with one another (Hayek, 1945; Basu and Waymire, 2010). Such information is useful not just for investors but also for managers, for whom continual matching guides (uncertain) business decisions that reflect related costs and benefits (Waymire, 2009).
Against these perceived benefits, however, it must be noted that matching has never been particularly tightly defined. It tends instead to be used in a way that presupposes that it is understood, and to be illustrated with examples that are straightforward. For example, Hylton’s (1965) definition—‘assigning revenue earned and expense incurred to the accounting period in which these events occur’—leaves open both the concept and the practicality of the notion of ‘assigning’. AICPA (1961) states that ‘a major objective of accounting for inventories is the proper determination of income through the process of matching appropriate costs against revenues.’ Here again there is vagueness in the terms ‘proper’ and ‘appropriate’. There is the noteworthy use of the straightforward, specific example of inventories, but this is insufficient to justify matching as a general concept. Similarly, while matching was acknowledged historically in the FASB’s conceptual framework (SFAC 6, 1985), its meaning was left somewhat open. Para. 145 of
SFAC 6 describes the goal of accrual accounting being ‘to relate revenues, expenses, gains, and losses to periods’ which involves ‘matching of costs and revenues, allocation, and amortization.’ Quite why ‘allocation’ and ‘amortization’ are different from matching is not explained, although para. 146 notes that many expenses ‘are not related directly to particular revenues,’ while para. 148 states further that the period to which certain types of expense relate are ‘indeterminable or not worth the effort to determine.’ In short, SFAC 6 appears to struggle somewhat with matching, endorsing its importance while at the same time identifying (somewhat unclearly) that matching falls short of being generally applicable.
This problem of definition is one of a number of reasons for the matching concept falling out of favor with standard-setters. A second reason follows from Sprouse (1966), who argued influentially that the practice of matching corrupts the balance sheet, by allowing the creation of meaningless asset and liability balances. BC4.3(d) of the IASB’s ED appears to draw directly from Sprouse in dismissing matching as generating ‘a mere summary of amounts that have arisen as by-products of a matching process. Those amounts do not depict economic phenomena.’ If, therefore, the balance sheet becomes a device to enable smoothing in the income statement, then matching can be portrayed as a licence to engage in earnings management. In addition, and to the extent that investors are subject to cognitive bias, matching can be viewed as (unhelpfully) a mechanism for meeting irrationally-determined information needs, for example smoothing as a response to loss aversion, historical cost as a response to omission bias, or a focus on realized gains and losses in response to investors ‘mental accounting’ (Thaler, 1985; Hirshleifer and Teoh, 2009). A further reason for matching being out of favor is that it can be viewed as conceptually redundant. Barth (2008) notes that ‘matched economic positions will naturally result in matched accounting outcomes.’ The argument, which is based upon a balance-sheet perspective (and which bypasses the problems posed by uncertainty), is that if accountants get ‘right’ the recognition and measurement of assets and liabilities, then matching will take care of itself and does need to be defined or applied as a distinct concept. In its only reference to matching, the IASB’s Framework ED makes this point as follows (para. 5.8): ‘The simultaneous recognition of income and related expenses is sometimes referred to as the matching of costs with income. The concepts in this [draft] Conceptual Framework lead to such matching when it arises from the recognition of changes in assets and liabilities.’
While the stated objective brings focus to the types of information required by investors, it does not say anything directly about how accounting might convey that information. Likewise, the Framework’s Qualitative Characteristics are not so much a description of the properties of accounting information but, rather, of useful information in general. It is difficult to argue against a definition of relevant information that is ‘capable of making a difference in the decisions made by users.’ (para. 28) Nor is it unreasonable that information should ‘faithfully represent the phenomena that it purports to represent’ (para. 2.14), nor that it should be ‘complete, neutral and free from error’ (para. 2.15). Yet such characteristics are in themselves rather anodyne, because they do not lead to discriminating decisions about how the accounting is actually to be done: they might be characterised as virtuous but not concrete (see also Christensen, 2010). In spite of this lack of guidance, however, the Framework proceeds directly (from its Objective and Qualitative Characteristics) to a proposed ‘solution’, which takes the form of a conceptual analysis of criteria for recognition, along with a (limited) discussion of measurement and a (very limited) discussion of presentation.
What the Framework lacks is a characterisation of the primary problem that accounting should be designed to solve. Why, in principle, are users helped to understand ‘the amount, timing and uncertainty of (the prospects for) future net cash inflows’ by means of the structuring of economic resources and claims into a balance sheet, alongside the presentation of changes in those resources and claims in the income statement? Or, more succinctly, what is the design principle for accruals? The question is ‘answered’ only in the Framework’s vague assertion that ‘accrual accounting … is important because information about a reporting entity’s economic resources and claims and changes in its economic resources and claims during a period provides a better basis for assessing the entity’s past and future performance than information solely about cash receipts and payments during that period’ (para. 1.17). But why, and how, are accruals ‘better’? The Framework does not answer this question, except to note the truism that accruals-based earnings result from a change in net assets, and that ‘the reporting entity has increased its available economic resources, and thus its capacity for generating net cash inflows through its operations … (and) may also indicate the extent to which events such as changes in market prices or interest rates have … (affected) the entity’s ability to generate net cash inflows’ (para. 1.18).
In seeking to address this limited conceptualisation of accruals in the Framework, a starting point is provided by the residual income model (Preinreich, 1938; Edwards and
Bell, 1961; Peasnell, 1982; Ohlson, 1995). This model is of course simply a formal restatement of the discounted cash flow model, and so does not in itself demonstrate that the mechanism of accrual accounting is useful. It does, however, make transparent a formal relationship between book value, earnings and valuation. In turn, this suggests (even though it does not in itself demonstrate) that accrual accounting—the balance sheet and the income statement—can potentially serve as a ‘technology’ that captures and structures data in order to provide useful information. The task for the IASB, viewed through this lens, is to define, recognise, measure and present the articulated variables book value and earnings (and their components), in such a way that they are of greatest benefit to investors in making decisions under uncertainty.
4. Accrual Accounting under Uncertainty
Accruals are useful in accounting, even in the absence of uncertainty. There might, for example, be a known invoice outstanding for services received and consumed, for which an accrual provides better information about the (certain) current obligation and the (certain) recognised expense. This is useful in itself for contracting and stewardship purposes and, in situations where the expense is expected to recur, the (certain) accrual also becomes useful in forecasting the flow of (uncertain) future economic benefits. Critically, however, what characterises the decision-making context of investors is that they face uncertainty in making investments, and so they seek information not just about expected economic benefits but also about the uncertainty that those expected economic benefits may not actually be achieved. And, of course, it is the uncertainty that makes the investors’ task challenging. We will argue in this section that uncertainty is the principal driver of the need for accrual accounting in meeting investors’ (forward-looking) information needs, and that it therefore shapes the appropriate criteria for recognition, measurement and presentation. Stated more strongly, the primary role of financial accounting is to shed light with respect to the problem of uncertainty, and explicit acknowledgement of this role is therefore needed in the Framework to guide conceptual thinking.^3
To illustrate this argument, consider that, in the (hypothetical) absence of uncertainty, there would be no reason not to capitalise all expected (net) inflows on the balance sheet,
(^3) The Conceptual Framework of the Accounting Standards Board of Japan introduces uncertainty and its resolution with a concept of release from risk of investments , which is proposed to distinguish net income (realized) from comprehensive income (that includes unrealized gains and losses); Saito and Fukui (2016).
This limitation of the balance sheet under uncertainty opens up an informationally useful role for the income statement. As the residual income model illustrates, if book value does not capture the economic value of the entity (i.e. PBV is different from one), then earnings become value-relevant, in that the ‘missing’ value is explained by the present value of expected residual income. It is therefore the presence of uncertainty that enables a role for the income statement in providing flow-based, value-relevant information, to supplement the stock-based information that is (incompletely) provided by the balance sheet.^6 In this regard, the income statement reports earnings from (the joint use of) both recognized and unrecognized assets (Basu and Waymire, 2008; Penman, 2009), and earnings provide the basis for extrapolating what is known about the past into a capitalised estimate of an unknown future. There is, however, no discussion of this issue in the Framework, and not surprisingly therefore, there is also no conceptualisation of the information-usefulness of the income statement. While the Framework does refer to the notion of ‘predictive value’ (para. 27), and thereby to some relationship between a ‘known’ past and an uncertain future, the reference is too vague to be insightful.
This capitalization of earnings is, however, problematic under conditions of uncertainty. This is because currently-incurred resource outflows cannot be amortised via the accrual mechanism in a way that corresponds periodically to future resource inflows, for the simple reason that the amount and timing of those inflows is uncertain. This impossibility of matching (and the inevitability of mismatching) is the underlying weakness in calls for an ‘income-statement approach’, as an alternative to the balance-sheet approach adopted by the IASB (Storey and Storey, 1998). In effect, an income-statement approach amounts to willing a solution by denying the problem. ‘Perfect matching’ is desirable as the basis for valuation under uncertainty, and it gives the Price-Earnings (PE) ratio its surest practical foundation (Black, 1980), yet it is unachievable for precisely the reasons why it is desirable, namely that it exists only in the absence of uncertainty (Solomons, 1961).
This discussion suggests a conundrum, a Catch 22, which is that perfectly matched earnings can be known only in a setting where they do not need to be known, while such earnings become unambiguously useful only in a setting where they cannot be known (Beaver and Demski, 1979). Yet this would be to state the problem in stark terms, with reference to the impossibility of perfect matching. We will argue that addressing the
(^6) The absence of progress on the Financial Statement Presentation project is evidence of this conceptual blind spot, as is the Framework’s neglect of definitions of income and expenses (Barker, 2010). See Penman (2016) for a financial statement design that embeds some of the ideas in this paper.
conundrum requires acknowledging that imperfection is unavoidable, while identifying that its consequences can nevertheless be minimised. Our approach acknowledges the decision-usefulness arising from the articulation of the balance sheet with the income statement. In contrast, the Framework’s approach, which is discussed in the next section, is to address uncertainty in the context of balance-sheet recognition and measurement only. We argue that this approach is incomplete, because it does not consider the inevitable mismatching under uncertainty that corrupts information in the income statement. Not least, while all accruals can be described as being motivated by what happens in the reporting period, the Framework does not develop this periodicity, implicitly treating income statement accruals as by-products of recognition and measurement decisions made at specific points in time.
5. Uncertainty in the Framework
The Framework explicitly discusses uncertainty with respect to the recognition and measurement of (net) assets. In addition, however, we will argue in this section that the definition of (net) assets also incorporates an important, implicit acknowledgement of the role of uncertainty in accounting. This latter, unacknowledged role is important, yet also ‘incomplete’.^7
With respect to recognition, the Framework identifies both e xistence uncertainty , defined simply as ‘uncertainty about whether an asset or a liability exists,’ and outcome uncertainty , defined as ‘uncertainty about the amount or timing of any inflow or outflow of economic benefits that will ultimately result from an asset or liability’. Existence and outcome uncertainty can both be understood as relating to the amount and timing of expected economic benefits and, without loss of insight for the purposes of this paper, they can be combined; we use the term fundamental uncertainty for this combined concept. With respect to measurement, meanwhile, the Framework defines ‘measurement uncertainty’ as ‘uncertainty that arises when the result of applying a measurement basis is imprecise and can be determined only with a range.’^8
Uncertainty is also implicit in the Framework’s definition of an asset. An asset is defined as ‘a present economic resource controlled by the entity as a result of past events,’ where
(^7) We note that the Framework does not make the conventional distinction between ‘risk’ and ‘uncertainty’, where the former is concerned with an expected distribution of payoffs (with knowledge of the underlying ‘system’) and the latter with a future that is fundamentally unknown (Knight, 1921). 8 With respect to ‘measurement uncertainty’, the Framework attempts to draw a line (though somewhat vaguely), applying a test of ‘relevance’ for whether ‘measurement uncertainty is high’ (para. 2.13).
dispersion of possible outcomes. Such cases are unavoidable in practice, as accounting standards have to ‘draw a line somewhere’. The accounting says: prospective customers may well suggest expected cash flows (economic benefits), but this expectation is not booked as an asset because of uncertainty around the expectation.^11 Accordingly, while investors may anticipate future revenues and price the firm accordingly, the accounting informs that those anticipated revenues are uncertain—the anticipated customers may not show up. Or, in the words of the Framework, the rights and control of an asset as a result of a past event have not been established.^12 With respect to revenue, therefore, both the Framework and IFRS 15 can be viewed as implicitly acknowledging uncertainty in recognition and measurement. This provides useful information because it enables investors to ‘know’ the economic inflows of the reporting period. An implication is that IFRS 15 enables an income-statement approach, albeit as the by-product of a balance- sheet approach. Revenues are recognized under a principle that connects (albeit implicitly) the income statement to uncertainty resolution. For the forward-looking investor, facing uncertainty, this periodic reporting of (earned) revenue enables extrapolation of a future flow based upon the evidence of a past flow.
6. Expense Recognition under Uncertainty
In comparison with revenue, however, it is more difficult to argue that the Framework’s balance-sheet approach provides similarly useful income-statement information for expenditures incurred to generate future (uncertain and unrealized) revenues. This is because of the inevitable mismatching that arises under uncertainty and the associated corruption of earnings information that results.
The expected benefits from an entity’s expenditures are uncertain in timing and amount, including those relating to, for example, inventory, fixed assets, research and development investments, brand-building investment, supply chain development, investment in product distribution systems, start-up costs and software costs. This is a problem that increases to the extent that expenditures are associated with longer time periods, as for example when the life of plant and equipment is longer than the revenue cycle. The question here is which expenditures should qualifies as resources controlled by the entity. 13 While
(^11) The delay in recognizing expected revenues that is implicit in the Framework definition of an asset amounts to a prescription for (conservative) accounting whereby PBV is greater than one (Barker, 2015). 12 Penman (2016) connects accounting under uncertainty to the required return for investing, and reports on empirical research where features of accounting that involve delayed recognition of earnings are associated with risk to investment outcomes and with average stock returns that are a reward for that risk. 13 See, for example, the basis for conclusions in FAS2, SFAS141 and 141R.
inventory, fixed assets, and some development and software costs appear on the balance sheet in satisfaction of the asset definition, many of the other investments satisfy the requirement of expected economic benefits yet are expensed immediately. Consistent with the argument in Brouwer et al. (2015), it is largely left to individual standards to draw the line, without the benefit of explicit guidance from the Framework. In IAS 38, for example, the IASB applied the criterion of “probable future economic benefits” to distinguish between “research” (which is expensed) and “development” (which is capitalized and amortized). 14 As argued above, this incompleteness in the Framework arises because the central role of uncertainty is not acknowledged explicitly; while the need to ask which resources are ‘controlled’ arises only under conditions of uncertainty, it is only at the standards-level, rather than in the Framework, that the consequences of this need are ‘thought through’.
A further complication is that the value of assets need not be realised in use (as is implied by the process of amortisation) but instead value can be realised in exchange. This distinction matters for uncertainty resolution because, from the reporting entity’s perspective, if there are deep and liquid (‘active’) markets available in which to trade the asset, then fundamental uncertainty can be transferred to a different entity by means of a market transaction. Such a case can be said to demonstrate low realization uncertainty. To illustrate, there might be an active market for an asset (such as a derivative financial instrument) which has a high outcome uncertainty, in which case the entity has a certain payoff if the value of the asset is realized immediately, notwithstanding an uncertain payoff if the asset is instead held. This realization uncertainty is similar to, though not quite the same as, the IASB’s notion of measurement uncertainty. The difference is that it is explicitly concerned with the existence of markets as mechanisms for certain realization (Beaver and Demski, 1979), as opposed to being concerned with the (closely related) concept of precision in applying a measurement basis.^15 To illustrate the difference, an amortization schedule for a financial asset could be applied precisely, even if there is no active market in which the asset could be sold for a certain amount; this would be low measurement uncertainty but high realization uncertainty.
It follows from this discussion that accounting for assets is concerned with two types of uncertainty. The first is fundamental and resolved only over time, with the implication for
(^14) In justifying the immediate expensing of R&D in FASB Statement No. 2, which predates the conceptual framework, the FASB focused on the “uncertainty of future benefits.” 15 A setting of perfect and complete markets is equivalent, in terms of economic opportunities and implications for accounting, to a setting of fundamental certainty (Beaver and Demski, 1979).
ex post asset write-downs (or, indeed, write-ups), that result from ex post amortization differing from the ex ante scheme. That likelihood might be ascertained from the possibility of not realizing revenues (or, in the case of realization uncertainty, that the carrying amount of the asset is not recovered directly). So, for example, and as implemented in IAS 38, that likelihood might be considered to be too high for Research but acceptable for either Development or for software that has passed the “technical feasibility” point. Amortization uncertainty might alternatively be established from the likelihood of a sizable gain or loss on de-recognition; that gain or loss should be small ( ex ante ) relative to revenues over the life of the asset. Write-downs and de-recognition gains and losses (both of which are ‘remeasurements’) reveal uncertainty ex post rather than ex ante , and so a desirable property of financial accounting is that the likelihood of write- downs (or write-ups) is minimized, reducing the ex post reporting of uncertainty. As with amounts recognised on the balance sheet, there is income-statement consistency here with the Framework’s ‘enhancing’ qualitative characteristic of ‘verifiability’, which is implied in any given reporting period by requiring amortization to be evidence-based and/or requiring low uncertainty with respect to realizable gains or losses.
An implication, for items meeting the definition of an asset but failing to meet the criterion above, is that write-downs are taken ex ante , with immediate expensing arising from non- recognition. That means mismatching in the current period, but a mismatching that conveys uncertainty ex ante , with lower earnings and lower asset recognition. In much the same way as uncertain prospective revenues are omitted from the balance sheet, so too are expenditures for which revenue outcomes are deemed to be uncertain. Accordingly, while mismatching is inevitable—it must occur, either ex ante or ex post —the mismatching is employed in an informative way.
In addition, this approach to accounting for uncertainty provides useful income-statement information for stewardship purposes. Revenue recognition under IFRS 15 requires the management to consummate sales in order to be rewarded. Plans, prospects, and promises are not enough; to be rewarded, the manager must see the plan through to realization, whereby uncertainty is resolved and, after matching expenses, profitably so. As sales are realized on the resolution of uncertainty, this locates the issue of managing under uncertainty with the manager. Similarly, with the non-recognition of assets above threshold uncertainty, the management is not likely to be rewarded on earnings that later will be erased with a (“big-bath”) write-down of assets of uncertain value (after the manager leaves).
This discussion of matching and of earnings invites consideration of income-statement presentation, a subject on which the Framework is essentially silent. Specifically, and as we explore in the next section, the application of the above balance-sheet approach leads naturally to what can be regarded as different types of matching (or mismatching), and categorising these types provides an insight into income statement presentation. In turn, as we will argue, in Section 8, further insights then follow with respect to balance sheet measurement. The common theme is that, in contrast with the approach in the Framework, our approach is motivated by consideration of the information-relevance of both the balance sheet and the income statement, rather than the balance sheet alone.
