FASB votes to finalize Chapter 5 on recognition and derecognition in the conceptual framework

The FASB on May 17, 2023, voted 6-1 to finalize proposed concepts Chapter 5, which determines when a company should incorporate into or remove an item from its financial statements.

The vote means that Proposed Statement of Financial Accounting Concepts No. 2022-ED400, Concepts No. 8—Conceptual Framework for Financial Reporting–Chapter 5: Recognition and Derecognition, will be finalized with editorial changes. The proposal was issued in November 2022 to update old recognition and derecognition concepts that have been around since 1984.

FASB member and academic Christine Botosan, the sole dissent, said she preferred to wait until discussions on the concepts chapter on measurement – which started at the same meeting – have concluded so that the board can more cohesively address the issue of “ relevance” in the recognition criteria under proposed Chapter 5.

“We’ve been working on the conceptual framework for 50 years, and we’ve not ever had any measurement principles in our conceptual framework up until this point in time,” Botosan said. “So I don’t want to put the cart before the horse and finalize this assuming that we’re going to end up finalizing a measurement chapter which is adequate to the purpose.”

Overall, the proposal received 12 comment letter responses, most of which agreed with the revised concepts, according to the discussions.

Board redeliberations focused on three issues that were flagged by respondents, including the recognition criteria for an item to be required in financial statements. The full board affirmed that an item must satisfy three criteria to be recognized in the financial statements: definitions, measurability and faithful representation.

The board had proposed that an item must meet the definition of an element, be measurable with a relevant measurement attribute, and be capable of being depicted and measured with faithful representation to be recognized in financial statements. Most respondents agreed, but a few questioned whether the “faithful representation” criterion is necessary, a staff person told the board.

FASB staff recommended that the board retain “faithful representation” as its own criterion, stressing that it is an important part of the recognition process. If there were an instance in which an item could not be faithfully represented, then it should not be recognized. A paragraph will be included in the ‘basis for conclusions’ section of the chapter to better explain why faithful representation is included as its own criterion, staff said.

The board agreed by 6-1.

“The issue for an investor is ‘faithful representation’ and ‘relevance,” FASB member Gary Buesser said. “The first two - ‘definitions’ and applicability of course are very important but again it’s the relevance to an investor, [i.e.], how do I value a company, how do I make future cash flows forecast, earnings forecast, so therefore all of that has to be combined,” he said. “I think the faithful representation is fine and should be left in there.”

The FASB also affirmed:

• by 6-1, that the qualitative characteristic of “relevance” is appropriately captured in the recognition criteria (with editorial changes);
• unanimously, that derecognition occurs when an item fails to meet any of the recognition criteria.

The conceptual framework is a document of Chapters 1-8, which provide the foundational concepts that the FASB uses to determine the way items like assets, liabilities, revenues, and expenses get recorded in financial statements filed with the SEC.

The framework is used by the board as a foundation to build accounting standards and related disclosures so that they are cohesive and comprehensive. The concepts are not authoritative, which means they are not generally accepted accounting principles (GAAP).

The FASB issued its first Concepts Statement in 1978 and issued six more by 2000.

Discussions on the conceptual framework started in 2004, which resulted in Chapter 1, The Objective of General Purpose Financial Reporting, and Chapter 3, Qualitative Characteristics of Useful Financial Information, of CON 8. In 2021, the FASB added two chapters: Chapter 4, Elements of Financial Statements, and Chapter 7, Presentation, of Conceptual Framework (CON) 8. Recently, the board completed Chapter 2: The Reporting Entity.

To be completed, the conceptual framework still needs one more chapter: measurement.

We have partnered with Thomson Reuters to issue our monthly Accounting Insights. Please contact Baker Tilly if you have any questions related to these articles or Baker Tilly's Accounting and Assurance Services. ©2023 Thomson Reuters/Tax & Accounting. All Rights Reserved.