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This article was first published in the July 2012 Irish edition of Accounting and Business magazine.
The SME Implementation Group (SMEIG) is a forum that considers implementation questions raised by users of the International Financial Reporting Standard for Small and Medium-sized Entities (IFRS for SMEs). It has published implementation guidance as a series of questions and answers. This article will detail the final published questions and answers to date.
In some countries, parent entities prepare separate financial statements as well as consolidated financial statements. The first SMEIG Q&A was whether a parent entity, which is required to present consolidated financial statements in accordance with full International Financial Reporting Standards (IFRS), can present its separate financial statements in accordance with the IFRS for SMEs.
The IFRS for SMEs is intended for non-publicly accountable entities that publish general-purpose financial statements for external users. If a parent entity does not itself have public accountability, it can present its separate financial statements in accordance with the IFRS for SMEs even if it presents its consolidated financial statements in accordance with full IFRS. The parent may use the IFRS for SMEs in its separate financial statements on the basis of its own public accountability without considering other group entities.
A parent entity has public accountability where its own debt or equity instruments are traded in a public market (or it is in the process of issuing such instruments for trading in a public market) or it holds assets in a fiduciary capacity for a 'broad group of outsiders' as part of its main business.
If a publicly accountable entity applies the IFRS for SMEs in its financial statements, it cannot describe those financial statements as complying with the IFRS for SMEs. However, a subsidiary that is part of a group that uses full IFRS is not prevented from using the IFRS for SMEs in its own financial statements as long as it does not have public accountability.
The IFRS for SMEs identifies banks, credit unions, insurance companies, securities brokers/dealers, mutual funds and investment banks as examples of the type of entity that 'typically' holds assets in a fiduciary capacity for 'a broad group of outsiders' as part of its main business. The second SMEIG Q&A was whether all those types of entities could automatically be assumed to have public accountability.
There is no simple answer here, as judgment will be required to assess whether entities have public accountability. Part of the definition of public accountability relates to the ability of external parties that make economic decisions to demand reports tailored for their particular information needs. Typically, depositors in banks, holders of shares in mutual funds, etc, are not in a position to demand such reports, so the entity is presumed to have public accountability even if it holds the assets for only a short time. 'Broad group' implies that the involvement of only a few individuals would mean that the entity would not be considered publicly accountable. However, there is no simple rule on what constitutes a broad group and so judgment will again be necessary.
Trading in a public market
The third SMEIG Q&A continued with the theme of public accountability by considering how broadly 'traded in a public market' should be interpreted. Did it refer only to regulated markets or did it also cover other markets such as growth share markets and over-the-counter markets? 'Public market' is defined in the IFRS for SMEs as 'a domestic or foreign stock exchange or an over-the-counter market, including local and regional markets'.
The definition includes all markets that bring together those capital-seeking investors that are not involved in managing the entity. The market must be accessible by a 'broad group' of investors. If the exchange is simply between parties involved in managing the entity, the market is not public. Advertising by a shareholder does not, by itself, create a public market; neither does the availability of a published price mean that an entity's debt or equity instruments are traded in a public market. There is no definition of 'public' in the IFRS for SMEs but it is usually considered to mean affecting a community as a whole; as set out above, it could be open to a broad group of outsiders, even if trading is infrequent.
There are a number of exemptions in the IFRS for SMEs on the basis of 'undue cost or effort' or because the requirement is 'impracticable'. The 'impracticable' exemption applies where an entity cannot apply it after making every reasonable effort to do so. However, 'undue cost or effort' is not defined and SMEIG was asked to explain the term. It involves a consideration of how users' economic decisions could be affected by the non-availability of information and so requires judgment.
'Undue cost or effort' is specifically applied for some requirements but not all. Where 'undue cost or effort' is used in conjunction with 'impracticable', the application of the standard should be as if 'undue cost or effort' had been used on its own.
The definition of 'impracticable' in the IFRS for SMEs is the same as under full IFRS and refers to effort and not cost. The inclusion of 'undue cost or effort' for certain requirements in the IFRS for SMEs is intended to point out that cost is a consideration.
The International Accounting Standards Board (IASB) feels that a requirement would result in 'undue cost or effort' where the cost or the employee effort would be excessive in comparison with the benefits gained by users of the SME's financial statements from having that information.
Often a jurisdiction will require that a certain recognition and measurement policy is followed that is dealt with in full IFRS and not specifically covered by the IFRS for SMEs. The question then arises as to whether the SME in that jurisdiction can state compliance with the IFRS for SMEs. In the absence of specific requirements in the IFRS for SMEs, management must use its judgment in adopting a reliable and relevant accounting policy. The IFRS for SMEs sets out the following hierarchy to help decide the appropriate accounting policy to use:
A) the requirements and guidance in the IFRS for SMEs dealing with similar and related issues; and
B) the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses and the pervasive principles in the standard.
The IFRS for SMEs also states that management may also consider the requirements and guidance in full IFRS that deal with similar issues providing that they do not conflict. This requirement does not allow a free choice to apply full IFRS requirements when there is a specific requirement existing in the IFRS for SMEs. If the IFRS for SMEs contains different guidance to full IFRS, the entity will not be able to state compliance with the IFRS for SMEs unless the effect is immaterial.
IAS 39 vs IFRS 9
A related question has arisen with IAS 39, Financial Instruments: Recognition and Measurement. The IFRS for SMEs gives an entity the option of applying the recognition and measurement provisions of IAS 39 to all of its financial instruments instead of following the SME standard. The question arises as to whether an entity can choose to apply the provisions of IFRS 9, Financial Instruments. The IFRS for SMEs refers specifically to IAS 39 and thus SMEs are not permitted to apply IFRS 9.
The reason for this is that the use of IFRS 9 by SMEs would require a change to the IFRS for SMEs. The IASB intends to undertake a thorough review of the IFRS for SMEs and at that time it will also consider new and amended IFRSs that have been issued since the IFRS for SMEs was published, including the requirements of IFRS 9. The review is expected to be completed in 2014, so changes to the IFRS for SMEs would most probably be effective at a similar time to the effective date of IFRS 9.
If an SME follows the recognition and measurement principles of IAS 39, there is a requirement that exchange differences arising on translation of a monetary item that forms part of a reporting entity's net investment in a subsidiary should be recognised initially in other comprehensive income and be reported as a component of equity. The standard prohibits those cumulative exchange differences from being recognised in profit or loss on disposal of that net investment. Similarly, exchange differences arising on translation of a foreign subsidiary should be recognised in other comprehensive income but the standard does not mention recycling to profit or loss on disposal.
The question arose as to whether the cumulative exchange differences arising on translation are prohibited from being recognised in profit or loss on disposal of the subsidiary. The IASB has decided to prohibit all cumulative exchange differences recognised in other comprehensive income from being reclassified to profit or loss on disposal of the subsidiary. This requirement is a difference from full IFRS, and was drafted in order to eliminate the burden for SMEs of tracking the exchange differences after initial recognition.
The provision of non-mandatory implementation guidance by the IASB on the IFRS for SMEs has not been without critics. Some believe it is inconsistent with the objective of having a single, stable, standalone standard for SMEs. The IASB has recognised that providing less guidance than for full IFRS makes for greater diversity in practice on issues that were not addressed. By trying to remedy this, with non-binding questions and answers, it could be seen as calling into question the basic design of the standard and diluting the power of a single standard.
Graham Holt is an examiner for ACCA, and associate dean and head of the accounting, finance and economics department at Manchester Metropolitan University Business School