IFRS for SMEs... at last

A key milestone was passed when the long-awaited exposure draft of the IFRS to be applied by SMEs was published by the IASB. Richard Martin writes

By simply undertaking the project at all, the International Accounting Standards Board (IASB) has accepted that full-blown International Financial Reporting Standards (IFRS) are designed for listed companies. Other companies – and these are mostly small and medium-sized enterprises (SMEs) – need something more straightforward, accessible and in line with the needs of their stakeholders reading the accounts and the costs to the company to produce the numbers.

Yet many consider that IFRS for SMEs is the most important current project at the IASB. The potential take-up of this standard is much bigger than of full IFRS because of the vast number of small businesses in most economies. In the many countries around the world where IFRS are being taken up by listed companies in their drive for a common language of accounting, this standard may provide the blueprint for the convergence of national accounting systems to IFRS. Most do not want to have accounting for privately held companies on an entirely different basis from their large and listed companies, yet accept that full IFRS are designed for listed companies and therefore that something more relevant is needed.

Conditions and traditions vary in different countries. So the IASB has simply said that entities may not use this standard if they have public accountability, meaning listed companies of whatever size, or any financial institution (bank or insurance). Beyond that, it is left to national jurisdictions to determine any other restrictions (such as, perhaps, very large privately held groups). Its title may therefore be a bit confusing, since it is really a standard for non-publicly accountable entities, not just for those of small and medium sizes.

Shorter standard

What does the proposed standard look like? It is firstly a very much shorter document – a few hundred pages in place of a few thousand of the ‘big book’. It is, however, largely a condensed version of the full IFRS and not something rewritten starting with a blank piece of paper. This reduction has been achieved in a number of ways:

• removing certain topics (but read on)
• distilling the text of the remaining standards down to the main principles
• eliminating much of the surrounding explanatory text
• reducing some of the accounting policy options available in full IFRS (but read on)
• simplifying the measurement and disclosure requirements.

Each of these is examined below.

Exclusions

Certain topics dealt with in the ‘big book’ are excluded from the draft standard on the basis that these will be rarely needed. So share-based payments, agriculture, insurance, finance leasing as lessor, earnings per share and segmental reporting are not included. If a company has such transactions, or wants to show such information, then they must apply the relevant IFRS in full and there is a direct reference to it in the text. The IFRS for SMEs is not therefore a stand-alone document; there are a number of ways in which the ‘big book’ may still have to be consulted.

Principles only

Boiling down the requirements of the treatment to its main principles has been mostly done by reproducing the existing paragraphs printed in bold in the ‘big book’, the so-called black-letter text. This is easier in some cases than others; the relevant text of IAS 2 on inventories, for instance, has been pretty much taken word for word, while that for IAS 39 on financial instruments has, perhaps thankfully, been rewritten in a more straightforward way. Not all these rewritings may be considered helpful and easier. For example, those on deferred tax or on hedge accounting may leave people pondering on the significance of the different language.

The elimination of the explanatory material that is a major source of the page count reduction may be more controversial. Full IFRS tend to include paragraphs elaborating and explaining the principles, worked examples, application guidance and the bases for conclusions, setting out the IASB’s reasoning on the treatment of accounting issues adopted. The draft standard largely omits these, except for some of the examples on provisions and revenue recognition. There is clearly a balance to be struck between making the document longer and so, potentially, harder to use and providing sufficient explanation.

Options included

Full IFRS contain a number of optional accounting treatments which make them longer and more complicated; for example, the revaluation options for property, plant and equipment and for intangibles, or the choice to capitalise interest costs on construction or to write it off as incurred. These are all available in the IFRS for SMEs, but the more complex one is provided simply as a cross-reference for the user to apply the appropriate parts of the full IFRS. As with the rarely occurring items above, users will have to reach for the ‘big book’. However, it seems that countries may be able to take out some of these and end up with an even simpler version, containing perhaps fewer references to fair value.

Simplifications

There are significant disclosure reductions in the notes to the accounts to be welcomed – notably of segments and of the assumptions behind some of the more subjective numbers in the accounts. There is a disclosure checklist helpfully included. There are also some true recognition and measurement simplifications, for example:

• a simpler approach to financial instruments (having two categories of assets and not four, simpler hedge effectiveness tests)
• excluding value in use from the impairment calculation
• not requiring as routine an annual impairment test for goodwill
• including actuarial gains and losses of pension schemes in the profit and loss account.

With some of these (impairment and pension costs), the IASB will be denying to SMEs options available in full IFRS, and so seem likely to be controversial. These look to be cases where IASB may be trying to use IFRS for SMEs to introduce changes they would like to make to full IFRS. There are also new options for SMEs to expense all development costs and to state investments in associates and joint ventures at cost.

There are, of course, many measurement simplifications that were suggested to the IASB that it has not taken up. For instance, some queried the usefulness to SMEs accounting at all for deferred tax or share-based payments, others wanted a return to amortisation of goodwill, ending finance lease accounting, or the discounting of provisions, among many others.

Issues

The exposure draft is open for comment until 1 October 2007. It is accessible at www.iasb.org

Among the key questions that arise are:

• is the standard sufficiently stand-alone from the ‘big book’ of IFRS?
• is the balance right between keeping the text concise on the one hand and providing sufficient explanation on the other?
• do the simplifications of measurement and disclosures go far enough, or have some gone too far?
• is some of the rewriting helpful or confusing?
• how might it be applied in your country – who should use it and should any of the options be removed?

ACCA will be consulting its members as widely as possible on this and would welcome their views on the exposure draft.

A risk seems to be that people are making rather sweeping and instinctive reactions to the draft, already dismissing it as too complicated for SMEs. The options allow for further simplification. If it should be simpler, the draft may well be modified in response to suggestions on specific items. This is an important opportunity to develop both the global basis of accounting and to provide a relevant but high quality financial reporting system for private companies. It is worth a careful look.

Richard Martin is ACCA’s head of financial reporting.