Financial statements are trying to do too much.

What is the purpose of "general purpose" financial statements? The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) are undergoing a joint project on the Conceptual Framework, arguably the most important project on the boards' agendas. The reconstituted framework will impact all future (and likely, many past) accounting standards and will be a barometer for decision-making.

FASB's current framework has seven Concepts statements, the first being "Objectives of Financial Reporting by Business Enterprises" (CON 1). CON 1 acknowledges that financial statements are a central feature of financial reporting. The broader concept of financial reporting includes not only the financial statements but also other means of communicating information that relates, directly or indirectly, to the financial statements.

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I think it is important that in this joint project, the boards differentiate between the purpose of the financial statements and the purpose of financial reporting. A lot of issues related to the complexity in accounting standards come from the desire for the financial statements themselves to be everything to everybody, seemingly ignoring the ability to communicate to the user through disclosure. The body of users, as currently defined in CON 1, is exhaustive.

In a letter to the IASB last June, FEI's Committee on Private Companies' Standards Subcommittee notes that in the current conceptual framework, the definition of users is broad and includes "potential investors" and the "capital markets as a whole. This view results in an existing framework that focuses the purpose of financial statements prospectively on potential investment and credit decision-makers." Even for public companies, it becomes very difficult presenting financial statements for both existing investors and creditors, as well as potential investors.

This is unique to the U.S. In fact, in most other countries, the primary purpose of financial statements is stewardship: How efficiently has the company used its resources to run its business? (For those interested in an analysis of the differences between the U.S. and other countries, I highly recommend an excellent paper, Divided by Common Language, written by Tim Bush of Hermes Pensions Management, published by the Institute of Chartered Accountants in England and Wales).

Attempting to provide a company's value to both existing and potential investors represents an unreasonable expectation of what the financial statements can tell you. Managements should not be setting a value, but providing input that can be helpful in setting value. In my opinion, value should be based on forward-looking information (obtained principally via disclosure) based on expectations of market participants.

Don't we have thousands of analysts paid to provide that insight? Haven't they based their predictions on how current management has exercised its stewardship and on the predictive value of actual cash flows and the disclosure of future trends? Management should not have to predict the future--there are enough estimates inherent in the current accounting model.

CON 1, paragraph 21 states: "... estimates resting on expectations of the future are often needed ... but their major use is to measure the effects of past transactions or events or the present status of an asset or liability.... Users of the information need to assess the possible or probable impact of factors that may cause change and form their own expectations about the future and its relation to the past." Accounting for past events and valuation, which is forward-looking, are different animals. Focusing on future value creates unnecessary uncertainty, in addition to the judgment already required in reporting what a company has done.

Shouldn't all financial statements be used primarily to determine whether management has carried out its duties to existing owners? This has predictive value for existing owners and creditors. Paragraph 18 of CON 1 states that assets and liabilities "must be quantified in units of money." Some recent standards and proposals from FASB include values based on probability that are not reflective of what the company expects to receive or pay.

One has to question whether this is meaningful to any user. Why shouldn't the company record liabilities and assets at the amount they expect to receive or pay? Under current disclosure requirements, companies have an obligation to disclose information they believe would be meaningful for an investment decision. One argument heard from users is that if a number is not on the financial statements, it is not reliable. This perception is unfortunate, and has created an environment where FASB is trying to get as much information on the financial statements (versus from supplemental disclosure) as possible.

We have allowed financial statements to evolve to a point where they are trying to do too much. We have lost sight and focus as to their purpose. Purpose matters. Getting all constituents grounded in a common purpose of financial reporting, including a clear understanding of the limitations, is crucial. I encourage all of you to get engaged in the debate.