This Comment Letter was sent by BDO Global Coordination B.V. on behalf of BDO International, to Paul Pacter at International Accounting Standards Board on 7 July, 2005:
Dear Mr Pacter
Staff Questionnaire on Possible Recognition and Measurement Modifications for Small and Medium-sized Entities (SMEs)
We thank you for the opportunity to respond to the above questionnaire. We agree with the Board’s decision to produce IFRSs for SMEs designed to meet the needs of the users of the financial statements. It is therefore fundamental to the project that there is an understanding of the needs of the users of SME financial statements in order to determine which areas within the IFRSs can be simplified for SMEs.
What is an SME?
A key question is what is an SME? We do not believe the document is clear on this issue. The scope paragraph of the questionnaire notes: “A small entity that produces financial statements only for the use of owner-managers, or for tax reporting or other non-securities regulatory filing purposes, is not an SME as that term is used in this questionnaire”.
This implies that an owner-managed business that produces financial statements for its owners, for tax and for legal filing purposes appears to fall outside of the term “SME” as used in the questionnaire. It seems inconceivable that such entities would be precluded from using SME IFRS and required to use full IFRS if in all other respects they were an SME.
Although the IASB needs to establish what is meant by an SME for the purpose of producing an SME IFRS, in many counties local laws or regulations will determine whether or not an entity may or must apply SME standards. Often very small companies will be classed as SMEs without regard to whether they publish general-purpose financial statements for external users and should not be precluded from using SME IFRS.
Fall back to full IFRS
We do not believe that a mandatory fall back to full IFRS is appropriate. Instead the hierarchy in IAS 8 should be followed, i.e. management should use its judgement in determining the appropriate policy that results in relevant, reliable information. Thus, management would consider:
· similar situations in other parts of the SME IFRS,
· the Framework; and
· other standards, including full IFRS, based on a similar conceptual framework.
Further consultations
We note that you plan to hold public round-table meetings with preparers and users of the financial statements of SMEs to discuss possible recognition and measurement modifications. We would welcome the opportunity to participate in those discussions.
Specific questions
Our responses to the specific questions raised are set out below:
1. What are the areas for possible simplification of recognition and measurement principles for SMEs? In responding, please indicate:
· the specific accounting recognition or measurement problem for an SME under IFRSs;
· the specific transactions or events that create the recognition or measurement problem for an SME under IFRSs;
· why is it a problem; and
· how that problem might be solved.
(a) IAS 2 – measuring the cost of inventories.
We do not believe that the recognition and measurement requirements within IAS 2 would cause a problem for SMEs. IAS 2 allows certain techniques to be used in measuring cost, e.g. standard cost or the retail method, which may cause a problem for SMEs due to the potential complexity of the calculations. However, we believe that such techniques would only be used by larger companies mainly in the manufacturing industry or large retailers and would therefore not be a problem for SMEs.
(b) IAS 11 – Use of percentage of completion method for contracts and for service revenue under IAS 18.
We note that IAS 11 and IAS 18 require the use of percentage of completion method for construction contracts when certain criteria or definitions are met and consider it appropriate that a similar approach should apply to SMEs.
(c) IAS 12 - Deferred income tax.
We do not believe there is any specific recognition or measurement problem for SMEs in this area.
(d) IAS 17 – Lease accounting.
We do not believe there is any specific recognition or measurement problem for SMEs in this area.
(e) IAS 19 – measurement of defined benefit pension or other post-employment benefit liabilities.
Where the valuation approach required by the SME IFRS differs from that required by local legislation for funding or taxation purposes SMEs may find the cost of obtaining multiple valuations onerous. Is the cost of an additional IFRS SME valuation commensurate with the further benefit to the users of the accounts?
Consistency could be achieved from year to year and between local SMEs by accounting using the valuation approach required by local legislation for funding or taxation purposes.
(f) IAS 27 – Consolidation of subsidiaries.
In order to reflect a group’s position, it is important to retain the requirements of IAS 27 for SMEs. However, if a subsidiary has been acquired with a view to subsequent disposal, that subsidiary should not be included within the consolidated accounts of the group (see our comments on IFRS 5 later).
(g) IAS 28 & 31 – Associates and Joint Ventures.
As a general rule, SMEs should be required to equity account (or proportionately consolidate, in the case of jointly controlled entities (“JCEs”)) for interests in associates and JCEs, in line with IAS 28 & 31.
In some instances at an SME level it may be more difficult to obtain information at the investors year-end on a reasonable time basis and/ or in accordance with the investors accounting polices. The SME standard should address this situation. For example should the investment be carried at fair value instead?
(h) IAS 36 – Impairment of goodwill and indefinite life intangible assets.
We acknowledge that impairment testing for goodwill and indefinite life intangible assets can be complex and potentially a long exercise.
The requirement within IAS 36 for entities to perform impairment tests for such assets annually, regardless of whether there is an indication of impairment, is rather onerous for SMEs. However, it is necessary to retain the principles within IAS 36 so that goodwill and intangible assets are not carried at a value higher than their recoverable amount. We therefore suggest that SMEs should only be required to perform impairment reviews on goodwill and indefinite life intangible assets when there is an indication of impairment.
We also believe a simpler impairment test should be applied comparing the carrying value of net assets including goodwill with the fair value of the business.
(i) IAS 36 – Impairment of property, plant and equipment.
Further to our comments in (h) above, we believe that the requirements in relation to impairment of property, plant and equipment should be retained for SMEs.
(j) IAS 37 – Recognition and measurement of provisions and contingent liabilities.
We do not believe there is any specific recognition or measurement problem for SMEs in this area.
(k) IAS 38 – Capitalisation of intangible development costs incurred after commercial viability has been determined.
We do not believe there is any specific recognition or measurement problem for SMEs in this area.
(l) IAS 39 – Use of the effective interest method under IAS 39.
The effective interest method should be retained for SMEs.
(m) IAS 39 – Fair value measurements.
The fair value measurement requirements under IAS 39 are very complicated and onerous for SMEs. This is definitely an area where simplification for SMEs would be beneficial.
The cost of obtaining fair values for assets and liabilities could be very high. We therefore suggest that SMEs should only fair value those financial assets and liabilities when market prices are readily available.
SMEs should also continue to fair value derivatives (except embedded derivatives) so that they are recognised on the balance sheet.
(n) IAS 39 – Accounting for foreign currency forward contracts.
The requirements within IAS 39 for accounting for foreign currency forward contracts should be retained for SMEs.
(o) IAS 39 – Derecognition and/or hedge accounting provisions of IAS 39
The derecognition and hedge accounting provisions within IAS 39 should be retained for SMEs.
(p) IAS 41 – The fair value method of accounting for biological assets and agricultural produce at point of harvest.
Obtaining specialist valuation reports could prove to be costly for SMEs, especially where market prices are not easily attainable.
We therefore suggest that SMEs should be given a choice to either record biological assets at cost less any accumulated depreciation and any accumulated impairment losses or at fair value less estimated point of sale costs.
(q) IFRS 2 – Measurement of share-based payments.
As SME shares are not listed a market price is not readily available. In the absence of a local listed equivalent or index it may not be possible to estimate share price volatility (one of the inputs of the option pricing model). Future dividend levels may be uncertain and volatile as owners are able to exercise more influence on distributions. Thus, the fair value of share-based payments could be costly and difficult to ascertain and may lead to a meaningless figure.
We therefore believe that there should be more scope for the use of intrinsic value for equity settled share-based payments to employees. However, where there are cash-settled share based payments, an expense should be recorded based on the best estimate of the cash outflow in the future.
(r) Others
IAS 40 – Investment property - We do not believe there is any specific recognition or measurement problem for SMEs in this area due to the existence of a choice in policy of either depreciated cost or fair value.
IFRS 5 – Non-current Assets Held for Sale and Discontinued Operations – In view of costs v benefits, we believe that the requirements of IFRS 5 should not be applied to SMEs.
2. From your experience, please indicate which topics addressed in IFRSs might be omitted from SME standards because they are unlikely to occur in an SME context. If they occur, the standards would require the SME to determine its appropriate accounting policy by looking to the applicable IFRSs (the so-called “mandatory fallback”).
We believe that the IFRS for SMEs should be a comprehensive “one-stop shop”, similar to the Financial Reporting Standards for Smaller Entities (FRSSEs) that have been issued by the Accounting Standards Board in the UK. It should include all the recognition, measurement, presentation and disclosure requirements for SMEs. We agree with the Board’s decision to adopt a topical sequence to the IFRS for SMEs and suggest following the FRSSE approach which also includes derivation tables and simplification tables.
We do not think a “mandatory fallback” approach is appropriate and believe that the “one-stop shop” approach is more advantageous and straightforward for SMEs.
We hope the above comments are of assistance. If you wish to discuss any of the points raised in our submission please contact Helen Thomson on 32-02-779 0130.
Yours faithfully
BDO Global Coordination BV