Fine-tuning of liability definition continues

The Financial Accounting Standards Board (FASB) still needs time to nail down a definition of a key financial reporting term: a liability.

Discussions on Aug. 22, 2018, revealed continuing divisions among FASB members on how to update the elements portion of board’s Conceptual Framework, the internal document the FASB uses to help it set consistent accounting standards.

While the existing framework has a definition of a liability, the FASB has not always referred to it when making standard-setting decisions. This means inconsistent guidance throughout U.S. generally accepted accounting principles (GAAP) on what is a liability versus an asset. The inconsistent guidance has created “a complex accounting model for financial instruments that have characteristics of both liabilities and equity,” according to FASB background materials.

“This has been debated for 40-plus years at some level what the dividing line is,” said FASB Vice Chairman James Kroeker toward the end of the meeting, when the FASB was no closer to an answer than at the beginning.

At the beginning of the meeting, the FASB’s research staff suggested the board simplify the existing definition of a liability by proposing that “obligations to sacrifice an entity’s assets and its own shares are liabilities.”

But as the board debated the merits of this proposal, several members said such a definition would not be so simple, in part because if the FASB were to adopt such language, existing areas of U.S. GAAP would no longer be consistent with the board’s framework. In addition, it could hold up the FASB’s separate project to answer long-standing questions about determining the difference between liabilities and equity for certain financial products.

FASB Chairman Russell Golden said the staff’s approach could lead the board to essentially ignoring the Conceptual Framework definition of a liability and using a different definition when sitting down to write standards. The staff, however, told Golden that the board should focus on setting a consistent definition first and then worrying about how to measure liabilities later.

“What our difficulty is, me included, is that I don’t like answering the what unless I know the where and the when,” Golden said. “That’s the difficulty I’m having.”

Other members of the board urged their colleagues to keep consistency in mind as they considered a new liability definition. FASB member Harold Schroeder cautioned against the approach that Golden advocated, saying the board needed to nail down concepts first before attacking standards-level problems.

“We’re going to keep solving little one-off problems and getting the same inconsistent answers between standards and between boards over time,” Schroeder said. “And so the only way to resolve that is to work on the elements and... finish whatever we need in Conceptual Framework.”

Under the existing definition, outlined in Concepts Statements (CON) No. 6, Elements of Financial Statements, liabilities are present obligations that require future sacrifices of assets. But the FASB over the years has strayed from the definition in its standard-setting practice, and U.S. GAAP has guidance that conflicts with the definition in the board’s Conceptual Framework.

“The current definition says there’s no liabilities unless you’re obligated to deliver assets. You categorically both — the International Accounting Standards Board (IASB) and the FASB — have consistently ignored that,” said James Leisenring, a former member of both the FASB and IASB who remains a senior advisor to the FASB and its staff.

The FASB at the end of the meeting agreed that it needed to do more work before deciding how to proceed.

The discussion was part of the board’s effort to revise its Conceptual Framework. The FASB issued its first Concepts Statement in 1978, five years after the FASB’s founding and published six more by 2000, but the overall Conceptual Framework is considered incomplete. CON No. 6 was published in 1985 and defines the “building blocks” with which financial statements are constructed, including the definitions of assets and liabilities.

CON No. 6 describes assets as “probable future economic benefits obtained or controlled by a particular entity as the result of past transactions or events.” Liabilities are “probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.”

Several terms in the definitions — including “probable,” “future economic benefit,” “past transaction or event,” “future sacrifice of economic benefits” and “control” — have sparked debates in accounting circles and cause problems in practice, FASB staff accountants have said.

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