Dear Sir,
Proposed IFRS for Small and Medium-Sized Entities
We are pleased to have the opportunity to comment on the above Exposure Draft (ED) issued by the International Accounting Standards Board (IASB), on behalf of BDO International1.
Our responses to your specific questions are set out below, with other detailed observations included in the Appendix to this letter.
The need for a version of IFRS applicable to companies and groups which are smaller and less complex than large public groups has become increasingly apparent. This draft document, while allowing for several areas of improvement, is a good foundation for discussion and we welcome the progress to date.
However, certain fundamental issues need to be resolved before the detailed accounting approach can be fully considered. These include the scope of an SME IFRS, user needs, the relationship between SME IFRS and full IFRS, the degree of choice in measurement techniques, and disclosures. We discuss these aspects below.
We also believe that there are significant areas where further consideration of the appropriate approach is needed. These include, in particular, financial instruments, share based payments and tax. The financial instruments proposals could easily lead to confusion and will, in some areas, make financial reporting more difficult for preparers and less transparent for users. For share-based payments, a situation where it is permissible to ignore the fair values of goods and services received is a backward step in clarity of reporting, and cannot be dismissed as irrelevant, since large numbers of entities applying this standard will be subsidiaries of public companies who may reward their employees with shares in the parent, for which a different expense would be recognised from that which would arise if the employee worked for the parent. With accounting for tax, we would not recommend the introduction of inconsistencies with full IFRS through the removal of exemptions (such as the initial recognition exemption) which have been helpful to preparers of accounts under full IFRS.
Scope We believe it may be too ambitious to expect the ED to be suitable for all non-public entities. While the ED talks of its target as a typical SME, with around 50 employees, this is an arbitrary measure. In practice, entities which might use the ED will vary from large private companies with subsidiaries, to stand alone “micros” with tiny operations which are required, under their local regulations, to prepare and file statutory accounts.
It seems unlikely that one Standard will be appropriate for all of these entities. If the ED were to be genuinely helpful to the smallest entities, it would be expected to contain considerably less guidance in the more complex areas, and might include a number of measurement simplifications. This level of tailoring would, however, render it unsuitable for large private groups. As such we would strongly recommend that no attempt is made to fit the ED to the smallest entities. Instead, it should be aimed at medium and large non-public, and non publicly accountable, entities, with the question of how micros should account being left to local regulators, who would be expected to have greater knowledge of the precise requirements for small entities in their own jurisdictions.
Questions about the name of the Standard do not appear relevant to its development. If it serves its purpose, then the naming is nothing but a distraction. If, however, the scope is to be changed significantly, then a more appropriate name might be devised, such as “IFRS for medium sized and non publicly accountable entities”.
User needs
Much can be made of the various needs of stakeholders, with many concerns in particular relating to how easy or difficult some elements of the ED might be for preparers to apply. However, we believe that this should not be the focus. The UK concept of stewardship, which needs to be retained as a core concept within the proposed Conceptual Framework for Financial Reporting, notes that a key objective of general purpose financial statements is to allow investors to assess how well their money is being used. Concerns about difficulty of preparation must not take precedence over ensuring that users are told what they need to know, and in a way that they can understand.
Relationship to the development of full IFRS
If the resulting Standard is to provide a coherent and lasting framework for medium and large non-public, and non publicly accountable, entities, it must aim for a default position of consistency with full IFRS unless a simplified measurement option is applied. If the document is to be self contained then it must include its own justifications, and must fully take into account the thinking that has gone into the development of the full Standards. Small inconsistencies between the SME guidance and that in full IFRS at this stage can only widen into gulfs which it may become impossible to bridge; if there are planned optional or mandatory recognition or measurement differences, then these should be justified and explained. The SME Standard should also allow the application of measurement principles as determined under full IFRS without imposing the required disclosures associated with full IFRS. This is important to ensure consistency between entities; so that subsidiaries of public companies, who apply the SME standard rather than full IFRS, will be able to prepare accounts on a basis consistent with that used by their parent; and to allow entities that are preparing for potential IPO to apply full IFRS measurement principles without automatically having to apply full IFRS disclosure.
Where a topic is not covered in the SME Standard, the Board should resist calls to paraphrase significant additional areas from full IFRS in order to provide a completely self-contained document. While this might be popular with those who seek reliance on only one physical book, the point of full IFRS is that it was designed to be principles based. The only reasonable way to provide detailed guidance for certain areas without including such guidance in the final SME book is by cross reference.
The Board must look forward too. In particular, the new Conceptual Framework is in the process of development and could eventually put a different shape and tone into full IFRS. A balance is needed in refining the ED at this stage: it would be flawed to base it wholeheartedly on the principles underlying the old book when it is known that these will be subject to imminent change; on the other hand it would be seen as inappropriate to incorporate significant changes in thinking proposed in the new Conceptual Framework before they have been through the appropriate due process. Perhaps the most significant is that of defining the focus of the intended audience of general purpose financial statements. The wide range of user needs, and the acknowledgement that exceedingly diverse parties expect to be able to place reliance on accounts, could usefully be explained within the Basis for Conclusions of the ED. It is important both that the SME standard does not introduce concepts which remain open to debate and also that, to the extent that it does differ from the Framework, it is only by requiring a simplified approach.
Available simplifications
Certain areas within the ED recommend a recognition or measurement technique, and then go on to allow a simpler version if the preferred treatment would involve undue cost or effort. We believe that this needs careful consideration to avoid potential abuse. The Standard must be robust, and it will be futile to recommend a “difficult” answer if an “easy” one is available and given equal prominence. At the very least, the notion of undue cost and effort should be examined and then defined so that an ‘easy option’ is only available for use in rare circumstances.
Disclosures
The ED succeeds broadly in providing the right quantity of guidance to enable a company to prepare meaningful accounts which are not inconsistent with full IFRS, and as such is suitable both for privately owned entities, for subsidiaries in groups headed by public companies and private entities preparing for IPO. It is, however, onerous in its disclosure requirements. For wholly owned subsidiaries, in particular, many of the disclosures would either be interesting only to the parent (which can access the information in other ways) or might contain insufficient information to allow meaningful analysis by users (who would need to look to the group accounts for a full understanding of how the entity’s activities fitted in with broader strategies).
This outcome is almost inevitable if the existing model, of taking the full IFRS disclosures and removing the items considered to be unnecessary, is maintained. We would propose instead an approach of establishing which disclosures would be essential to users of SME financial statements, and requiring only those disclosures. This would often result in simpler financial statements and could reduce the time and cost of their preparation.
Minimum disclosure might include:
- Balance Sheet
- Income Statement
- SORIE
- Cash flow statement
- Accounting policy note (outlining in particular where simplified measurement options have been adopted or where the measurement principles of full IFRS have been applied instead of the approach included in the SME standard)
- Notes for items which are significant from a quantitative or qualitative perspective.
Question 1 – stand-alone document
Additional areas which should be covered
We consider that the Basis for Conclusions should be expanded, so that it also includes the thinking behind the areas that are the same as full IFRS: at present the Basis for Conclusions essentially only discusses reductions from, or modifications to, full IFRS. This would help to support the final SME book as one piece of coherent reasoning.
Guidance that should be removed
The key areas which are less likely to be relevant to SMEs (EPS, interims, and segment reporting) have already been referred to only by cross reference. The response to Question 6 below highlights some other areas which may be unnecessary for many users of the Standard.
Some local versions of “small GAAP” approach the less relevant areas by complete omission of both guidance and with no cross reference to the ‘full book’. This does not seem an appropriate approach: if an SME presents EPS, for example, its financial reporting could be highly misleading, if the entity was subject to no guidance on how this EPS should be calculated.
The detailed guidance at the end of the revenue chapter is a specific case of where guidance could be reduced – the provision of 25 examples appears excessive.
Question 2 – recognition and measurement simplifications
Recognition and measurement simplifications that have already been included in the ED
Financial instruments
The proposed accounting for financial instruments is not internally consistent, nor does it reconcile easily with the structure for classifying financial assets and liabilities in full IFRS. Our detailed comments are provided within the Appendix to this letter: their broad point is that the default to fair value rather than amortised cost seems unsupported; the removal of the “available for sale” category of financial assets is unnecessary; the removal of certain criteria for derecognition of financial assets will inhibit comparability ; and the (apparent) simplification of hedge accounting raises more difficulties than it removes.
Accounting for financial instruments is, at best, complex and difficult. The ED explicitly allows preparers the choice simply to apply IAS 39 and with the current drafting, this may be an appealing option. IAS 39 gives a full set of guidance where at present section 11 gives rise to all the difficulty without providing much assistance. If it is to be a useful section, it must be modified so that the approach is genuinely simplified and made easier to apply.
Goodwill impairment
The requirement for annual full impairment reviews could impose significant effort and cost, and seems unnecessarily onerous in situations where there is no reason to suspect impairment. Therefore we agree with the relaxation of the requirement, so that impairment reviews are only necessary when there are indicators of impairment.
We also agree that systematic amortisation of goodwill should not be permitted. This would create too great a difference between SME and full IFRS adopters, and would not be consistent with the IASB’s conclusions for those entities that report in accordance with full IFRS.
Treat all R&D costs as expenses
This is a simplification which is likely to be welcomed by SMEs, as it removes a requirement for recording and regular assessment which could have been onerous. It may also be considered more representative of the way in which smaller entities operate: research and development are less likely to be performed – or viewed – as discrete activities. Providing that the expense treatment is mandated (ie with no option to capitalise), there will be reasonable comparability between SMEs. Users who wish to compare SME accounts to full IFRS accounts in this area will be able to do this fairly easily, as full IFRS accounts will show clearly the total values capitalised and subsequently depreciated relating to development costs – so the needs of users are reasonably balanced with those of preparers.
We take issue, however, with the arguments advanced to support the removal of the capitalisation requirement. Similar arguments were put forward against IAS 38 (and previously IAS 9), but these were rejected based on the principles set out in the Framework: it was concluded that internally generated assets should be recognised based on the same criteria as those that are acquired externally. The BC section should be expanded to explain why this simplification is still considered to be compatible with the principles underlying full IFRS.
Cost method for associates and joint ventures
The justification for the removal of equity accounting as the default treatment for associates and joint ventures is that it is too difficult to obtain the required information. This is not acceptable: if accounts are to assist users in assessing the stewardship of management, then it seems unfortunate if management cannot identify the assets and results of investments over which they have significant influence. Moreover, it is unrealistic to suggest that in situations where this information is not available, it might still be possible to identify the fair values of such investments. If financial information is not available, how are fair values to be derived?
The existence of three choices for associate accounting does not seem to satisfy the aim of simplification, particularly when the cost model brings in a potential reduction in “cost” relating to distributions of pre-acquisition profits. Consequently, the cost model should be removed for consolidated accounts and permitted in individual company accounts only in situations where no other information is available.
Income taxes
The core principle, of recognising deferred tax on temporary differences, remains, meaning that (broadly) the treatment will be consistent with full IFRS.
Although it may be the case (as per BC85) that SME preparers stated their preference for an approach based on timing differences, this related to accounting rather than the description and explanations provided to them. The proposals are for deferred tax to be based on temporary differences, and it would be appropriate for it to be described as such.
Certain preparers and users consider the requirement to recognise deferred tax to be unnecessarily onerous, and argue that the presentation of the relevant information within the notes is sufficient. While this might bring simplification, it would be too far removed from and inconsistent with full IFRS, and would lead to recognition of current tax expenses that are not in line with the underlying principles outlined in the first chapter of the ED.
The removal of certain complexities contained in IAS 12, such as the initial recognition exemption, is in line with the general principle of simplified accounting, but has the unwelcome side effect of creating unresolved anomalies. For instance, paragraph 28.17 is opaque and needs to be redrafted to provide clear guidance to users on the prescribed carrying value of a newly acquired asset, and on how to determine the deferred tax arising on initial recognition of the asset. It appears that the lack of a coherent means of accounting for this contributed to the decision in IAS 12 to allow this exemption: if the SME Standard omits the exemption, then a fuller explanation is needed
The exemption in paragraph 38.8(f) from recognising deferred taxes on first time adoption if such recognition would involve “undue cost or effort” requires clarification on what is meant by a reasonable amount of cost or effort. It should also clarify whether it applies to individual items, or to an entire opening balance sheet position.
Agriculture
We agree with the principle that fair value is the most informative measurement basis for agricultural produce and that the relevant information would normally be available to preparers because such items are, by their nature, sold on active markets.
As with certain other areas, though, the proposals are made less effective because provision is made for an alternative measure in the case of cost or difficulty. Effectively this means that two options are presented, one of which reduces volatility: consistency cannot be achieved in this way.
We believe that, at a minimum, this section needs to be amended in order to freeze initial designations, and to require consistency in measurement bases between classes of assets. If this requirement is not added then entities will, effectively, be able to select their profits each year by choosing whether to re-measure or not. While the provisions in 2.9 on comparability go some way toward discouraging entities from such changes, it would be more appropriate to express such a prohibition directly in the areas where choices are offered.
Employee benefits
In principle, reducing the number of options available for accounting for defined benefit schemes is a useful simplification. However, we do not consider that it is appropriate to mandate immediate recognition of all actuarial gains and losses in the income statement. This will add volatility to the income statement where most of the other simplifications (for example, allowing associates to be held at cost) would reduce it, and is therefore inconsistent with other aspects of the proposed Standard; it would also make SME profits more affected by external factors than public company profits are.
We agree that it would, as stated in BC90, be inappropriate to create new accounting, recognising movements “direct in equity” rather than through the statement of recognised income and expense (SORIE). This is, however, a matter of semantics. A SORIE can be presented with very little pain if the only components are the profit for the year from the income statement, and actuarial gains or losses. This meets both goals of not having additional volatility in the income statement, and yet of still showing the movement clearly. It would also be consistent with an approach permitted by full IFRS.
Share based payments
IFRS 2 allows that where employees are remunerated through equity-settled share based payment arrangements, but the fair value of the equity instruments cannot reliably be measured, the services received may instead be measured at the intrinsic value of the options awarded. The SME standard includes this provision but omits the phrase “in rare cases”, which brings the potential for SMEs to default to this approach.
The issue with this relaxation is that ultimately employees are providing valuable services. If, as is often the case, options are granted at the share price on the date of grant, then there is no intrinsic value, and no expense will be recognised if an intrinsic value approach is followed, even though the employee is undoubtedly providing services and may receive less remuneration in other forms than comparable employees who have not been granted the option.
Remeasuring intrinsic value would give a charge each year, but it would be a backward step as it would be inconsistent with IFRS 2 and would also seem to negate the benefit of simplification that the Board is seeking to introduce. In addition, in some jurisdictions (such as the UK), local GAAP has converged with IFRS 2. A change to another approach would be undesirable. It is possible that preparers of accounts may have strong views about the difficulty of (and inconvenience involved in) measuring fair value. However, those who consider this to be a useful method of paying for goods or services or rewarding employees are likely to be in a position to assess what these payments are worth: it is disingenuous to suggest that entities issue shares (and providers accept them) without having some form of understanding of their value. The principles in IFRS 2 should not be removed in favour of a piece of slightly easier, and considerably less informative, reporting unless the required information either cannot be obtained, or cannot be obtained without involving undue cost and effort. Such instances should be rare.
Leases
We agree that requiring the initial measurement of leased assets to be the fair value of the leased item is an acceptable approach. However, it is not altogether clear why the comparison to fair value of minimum lease payments is removed: it is likely that entities will have this information available, and so appears to be a simplification for simplification’s sake.
First time adoption
Detailed comments on the approach to first-time adoption are included in our response to question 10 below.
Further simplifications that should be made
We disagree in general with the idea of simplifying the core accounting from IFRS: this could only detract from comparability if it results in fundamental recognition or measurement differences, particularly if the same language is used to point to different concepts.
The only area where it may be reasonable outside those discussed above is government grant accounting. It would be straightforward simply to require that entities credit grants received against the assets or income to which they relate, accompanied by disclosure.
Realistically, we believe that this ED is not designed for significant simplifications. Once a decision is taken to provide guidance in one area, then we consider that it is not appropriate to adopt selective silence on others.
Question 3 – recognition and measurement simplifications considered but not adopted
No cash flow statement
Cash flow statements are not difficult to prepare, and the information they provide is useful for users of financial statements.
On the other hand, UK GAAP allows subsidiaries where 90% or more of the voting rights are controlled within a group not to prepare a cashflow statement (provided the related consolidated financial statements are publicly available), on the grounds that their liquidity is usually managed within their group. It could also be argued that any user who is interested can work out a basic cashflow for themselves.
All leases as operating leases
Off balance sheet financing is decreasing in popularity and perceived acceptability, and should not be reintroduced here. Users at all levels need to be able to understand the levels of return on their investments, and they are not given a meaningful picture if assets which the entity, to all intents and purposes, owns, are not included on the balance sheet.
There also seems to be little point in introducing substantial changes at all on leasing while the leasing project is still underway.
All employee benefits treated as defined contribution
This proposal would ignore user needs: users are interested in an entity’s future obligations and the means by which it intends to satisfy them. It would also be a large rift between SME and full IFRS, without sufficient compensatory benefits to justify it. While it might be argued that disclosures could be included for defined benefit schemes, we consider that disclosure is not an adequate substitute for an appropriate accounting approach.
Non recognition of share based payments
Again this proposal does not take account of the thinking behind the development of IFRS 2.
Not recognising this part of the cost of employee services (or other services) would involve ignoring the definition of an expense.
No deferred tax
The proposal to allow non-recognition of deferred tax would be appealing from the perspective of some preparers, who argue that the benefits of calculating and recording deferred tax are not worth the cost and effort. It would not, however, provide great cost savings if disclosures of the relevant balances were still required.
This is a point where we believe the ED needs to remain strong. Dropping the requirement to account for deferred tax not only denies users information which is valuable to them (for instance if an entity is taking actions now which will lead to large future tax liabilities), but also is inconsistent with the framework underlying both the SME and full IFRS. The glossary to the ED defines a liability as “a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits”. Provisions for deferred tax are clearly included within this definition and their omission amounts to ignoring this.
Cost for agriculture (for biological assets)
This would appear to be another simplification for its own sake, and therefore should not be pursued.
No group accounts
The best justification for this would be on cost/benefit grounds: it can be argued that an interested user can get all of the information they need by looking at all individual entities. Group companies may often, however, trade on non arms length terms so separate accounts do not present a whole picture.
The alternative of mandating extensive related party disclosures would probably be even less popular.
Foreign exchange and revaluation gains/losses direct to P&L
This is a change rather than a simplification, and would damage comparability and create unnecessary volatility. It would also bring inconsistency with full IFRS.
Question 4 – accounting policy options
The Basis for Conclusions states that any reduction in the number of accounting policies available to SMEs will hinder comparability. It is not clear, though, that this is true. In certain cases, for instance the capitalisation of development costs, identical information can be provided to users by the adoption of either policy: development costs will either be apparent on the balance sheet or disclosed as an expense.
It does not seem likely that much value will be added by having one policy recommended and the other available: this will have exactly the same effect in practice as simply allowing two options at the outset, and will not really achieve the goal of simplification.
Investment property
The suggestion that the ED will recommend holding investment properties at depreciated cost, with fair value available through cross reference, is pragmatic, and in line with the broad idea that the ED will allow straightforward accounting to straightforward entities.
The removal of the requirement to disclose fair value for investment properties held at cost is, however, a serious omission as the disclosure requirement was included in IAS 40 to assist users with their resource allocation decisions. It ignores the fact that a key reason for holding investment properties is their capital appreciation.
Plant, property and equipment; intangible assets
As above for investment properties, the basic principle of a depreciated cost model wherever available seems to suit the type of financial reporting most likely to be useful for stakeholders of SMEs. It is, however, unclear how much benefit there is to this if the alternative model is also permitted.
Cash flow statement presentation
The indirect method of cash flow statement presentation is common amongst SMEs – so it is reasonable for it to be the standard choice.
Government grants
For grants relating to assets, the ED does not yet provide sufficiently clear guidance – the most obvious reading is that if the entity has no future obligations relating to the asset, and the asset is being measured at fair value through profit or loss, the whole grant can be recognised in income straight away; otherwise (if this condition is not met, or the entity elects not to take this option) it will be recognised over the asset’s expected useful life.
The ED is silent on whether the balance sheet credit should reduce the asset’s carrying value, or be shown separately as deferred income: guidance should be provided in this area, to improve consistency between entities applying the Standard.
Question 5 – borrowing costs
The ED allows entities the choice of expensing or (subject to the existing IAS 23 conditions) capitalising borrowing costs, which is effectively in line with the existing IAS 23. This is an appropriate approach, as an SME’s standard record keeping may not contain sufficient information to allow the assessments in IAS 23 that are required if an approach of capitalising is followed.
Even with the change to IAS 23 becoming effective from 2009, the more relaxed requirements for SMEs would be comparable with those allowed in respect of development costs. It is a simplification which is sufficiently apparent to the user, and therefore is appropriate.
Question 6 – topics not addressed
If the Board chooses to retain the model of a relatively slender document with cross references where necessary, then most of the judgements already taken on which topics should be addressed seem reasonable. There are, however, three further areas where the weighting could be changed so that the guidance is by cross reference alone.
Investment properties
It is unlikely that many smaller non-specialist entities will hold investment properties. For specialist property investment companies, condensed guidance would not be appropriate so they would need to look to the full book anyway. As such, little value is added by the inclusion of any version of the guidance in the ED other than cross-reference.
Discontinued operations
The reasoning behind not requiring segment disclosures should also be applied to discontinued operations. Entities reporting under the ED are less likely than public entities to have multi-strand or multi-location operations. It would therefore be less common for any restructuring which they undergo to be sufficiently fundamental to meet the definition of a discontinued operation, and therefore the guidance should be excluded from the text of the Standard.
Hyperinflationary economies
This guidance should be dealt with entirely by cross reference.
Question 7 – general referral to full IFRSs
The ED needs to commit more boldly to being either a subset of full IFRS, or a new document based on a separate framework. If it is, as we would hope, extracted from the same principles as those behind IFRS and designed to remain consistent with these, then it should mandate fallback to full IFRS (before looking to any other standards) if the SME guidance is not to be followed; if this is not the case then the SME Standard should distance itself further (for instance by removing the loophole allowing a move straight to full IFRS if the small book does not contain guidance on “similar and related issues”) [10.3(a)]
Question 8 – adequacy of guidance
Starting from the position that the ED will remain as it is with certain areas of guidance, certain areas of cross reference, and perhaps a slightly re-prioritised hierarchy involving more frequent fallback to full IFRS, there is no great need for more guidance. Full IFRS is always available for users who want it. There should not be fuller or more detailed guidance than that in the original standards: this could lead to too much risk of developing practice among SMEs which would be different from companies reporting in accordance with full IFRS.
BC118 notes that the Board does not want preparers to be allowed to select which parts of IFRS they apply because this would give them “almost an infinite array of combinations of accounting policies from which to choose”. This does not sound logical. Since the Standard has very few options open to SMEs that are not included in full IFRS, and full IFRS has some that are not available to SMEs, full adopters would seem to have a larger number of combinations of policies available.
Question 9 – adequacy of disclosures
As discussed above, we feel that a more successful model for the guidance on disclosures is one which started from a position of determining which disclosures would be of use to SME reporters and users of their financial statements, and not by looking at the full book and working out which disclosures users can live without. This is where a precise examination of user needs is crucial: if most of the target preparers are wholly owned subsidiaries or owner managed businesses, then shareholders, the most important stakeholders, do not need to be shown a mass of information to which they would, if they needed it, already have access. Even for other stakeholders, a subsidiary’s full activities can often only be understood by examination of its parent’s accounts: the subsidiary may (for example) be party to preferential trade terms and prices, or may benefit from participation in the parent’s pension and share-based payment schemes. Realistically there is little to be gained by requiring subsidiaries to reproduce disclosures which are publicly available elsewhere.
Reduced disclosure, however, will only be successful if the accounting framework of the ED remains congruent with full IFRS. This enables informed users to make certain key assumptions and to read SME accounts with the same frame of reference as they use to read full IFRS accounts. As soon as SMEs have a range of distinct measurement options, onerous disclosure will once more be necessary to ensure users are not misled (particularly if they read a subsidiary’s accounts immediately after its public parent’s, expecting them to be broadly comparable because they purport to be based on similar frameworks).
Question 10 – transition guidance
The transition guidance appears adequate. The exemption from the requirement to restate comparatives at the date of transition, however, appears unduly permissive. While there is clearly work involved in restating the comparative period, a reconciliation is necessary for a proper understanding of the accounting that is being applied in the first IFRS accounts.
Question 11 – maintenance of the Standard
Many SMEs will face significant challenges in preparing their first Standard-compliant accounts, and will have to make substantial investment in accounting systems and recording mechanisms. A reasonably stable platform would therefore be highly desirable at the outset: SMEs may not have the resources to respond rapidly to an ever evolving set of standards.
A time gap of two years between revisions is probably the longest that is acceptable. Beyond this, there will be too much separation between the versions of IFRS included in SME and full standards, meaning that SME accounts could lose any comparability which they had previously achieved with their public peers.
The issue with the process as currently envisaged is that the Standard contains many references to standards in full IFRS. If full IFRS changes, this could lead to inconsistencies within the Standard as a whole.
At the very least, the IASB should consider providing very specific cross referencing to individual paragraphs within the relevant IFRS, so that changes can be fully tracked; alternatively they might consider freezing these references at an “as at” date, so that the Standard will not change even if some of its original components do. Although there are logistical issues with this, it could mitigate the possibility of inconsistency.
In summary, we support the thinking behind the Standard, and many of the principles outlined within it. With a reduction in its scope, and reconsideration of the approach to disclosure requirements, as well as revision in certain areas, we believe that the SME Standard will fulfil its remit and provide a stable and widely relevant basis for non public entity accounts.
If you would like to discuss these comments, please contact Helen Thomson of BDO Global Coordination B.V. on +32 2 778 01 30.
Yours faithfully,
BDO Global Coordination B.V.
Appendix – Detailed Feedback by Paragraph
Glossary This is a helpful section but it would be more helpful if terms were also defined as they came up and then the glossary simply summarised those references (as in full IFRS).
Section 3 – Financial Statement Presentation
3.7 A reference to a 12 month time period for assessment of going concern should be added, mirroring IAS 1 (24).
Section 7 – Cash Flow Statement
7.12 - It should be clarified that the reference is to the entity’s, not the subsidiary’s, functional currency
7.12 - the phrase “minority interest” should be replaced with “non controlling interest” for consistency with full IFRS
Section 9 – Consolidated and Separate Financial Statements
Section 9 – we believe that this is too simplistic. Clarification should be included to make it clear that power to control without the actual exercise of control will still trigger a requirement for consolidation. Smaller entities may well have complex management structures/interrelations which mean that voting rights and control are not always clearly matched.
9.9 needs to clarify that potential voting rights are only relevant to control if they’re currently exercisable.
Section 11 – Financial Assets and Financial Liabilities
11.7 (measurement) We consider that it is too simplistic to provide “each reporting date” guidance rather than separating initial recognition from ongoing measurement.
There appears to be no guidance on transaction costs at origination (11.8 covers costs on disposal only) – this is mentioned in 11.16 but should be more explicitly addressed.
The initial accounting for compound instruments in 21.7 maintains a distinction between initial and ongoing measurement and is, therefore, inconsistent with section 11 as it stands.
More explanation should be included to support the decision to make holding instruments at fair value the default, with complicated conditions to qualify for amortised cost. BC78a acknowledges that this could lead to more burdensome fair valuing for SMEs in comparison with entities reporting in accordance with full IFRS. As noted above, we disagree with an approach which gives rise to inconsistency between SME and full IFRS reporting.
The removal of the Available For Sale classification is not properly explained, and does not seem necessary.
11.10 – there appears to be no real need for such a detailed list of examples – perhaps this could be relegated to the implementation guidance? The examples should not be necessary if the definitions are sufficiently robust.
11.24 derecognition of assets – consideration should be given to reinstating the “pass through” criteria – otherwise SMEs may be unable to derecognise assets that large companies could. BC 73(b) says this is unlikely to be relevant to SMEs but this ignores relatively common arrangements such as debt factoring.
11.32 should include a definition of “substantial” as in 39 AG62 – this is too important to leave to judgement, and as the ED is currently drafted there is no clear hierarchy that indicates that entities should default to full IFRS for interpretation.
11.30(d) – “highly effective” should be consistent with IAS 39.
11.32 – designation of a proportion of a derivative should be permitted, in the same way as it is permitted in IAS 39. Significant difficulties could otherwise arise- say, for example, a company takes out a USD/GBP forward with a notional of $1 million, which matches the anticipated value of sales revenue in Q2 next year. A number of the forecast sales then evaporate, so that only $600,000 are now highly probable. That will almost certainly fail to be classified as highly effective so hedge accounting ceases. Under IAS 39, it would then be possible for the company to redesignate 60% of the notional value of the derivative as the hedging instrument for the reduced value of sales. Under the SME rules, it would seem that this would be precluded.
11.36 – The treatment on discontinuance of hedge accounting, where changes recorded to date are amortised back to the income statement using the effective interest rate method, is much more logical for interest bearing items than for others such as inventory.
Section 13 – Investments in Associates
13.3 It should be clarified whether this means one accounting policy choice has to be made to apply to all associates.
Section 18 – Business Combinations
Consideration should be given to providing more guidance on attributing fair values to assets and liabilities acquired.
Section 19 - Leasing
This does not mention the need to split operating leases between land and buildings. The need to do this was a challenge for some companies when they adopted full IFRS so it would be appropriate to include explicit reference to this.
Section 20 – Provisions and Contingencies
Consideration should be given to adding guidance for situations where there is a continuous range of possible outcomes. Guidance is implied in the examples, but it would be better to include this in the front section.
Section 21 - Equity
21.2 indicates that unpaid share capital should be accounted for as an offset to equity in the balance sheet – this is a conceptual step away from full IFRS and careful consideration is needed as to whether this inconsistency is appropriate.
Section 28 – Income Taxes
Examples should be given for tax bases of liabilities as well as assets.
28.11 – this paragraph introduces some language which is then not used and does not appear necessary (for example, “inside basis differences”).
Section 30 – Foreign Currency Translation
30.9.(b) - it would be helpful to clarify which transaction is being referred to
Section 32 – Events after the End of the Reporting Period
32.7 – Many entities struggled to interpret this provision in IAS 10 - an explanatory paragraph should be added.
Section 33 – Related Party Disclosures
These disclosures appear lengthy and onerous, and represent an area where disclosure requirements could be reduced. Mandating detailed disclosures for such items could be a matter for local legislation rather than for accounting standards.
Section 38 – Transition to the IFRS for SMEs
38.11(a) & (b) might benefit from an illustrative example with dates (particularly as “date of transition” is not defined anywhere)
Proposed IFRS for SMall and Medium-Sized Entities, Comments due 30 November 2007:
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