top stories

Share

Comments from ACCA
June 2005

The Association of Chartered Certified Accountants (ACCA) is pleased to have this opportunity to respond to the above questionnaire which was sent to us by IASB for comment. It was considered by ACCA’s Financial Reporting Committee.

We first set out a few observations on the basis of our response and then our answers to the specific questions raised.

Definition of SMEs for this purpose

In our experience this has been one of the main difficulties that respondents may have had in developing their reactions to this project. For the purposes of this response we have tried to take what we consider is IASB’s definition of an SME. The IASB have defined SMEs, in the context of this project, as those entities that are not publicly accountable - that is, Non Publicly Accountable Entities (NPAE). NPAEs have been further defined by the IASB as excluding listed companies, financial institutions, public utilities and entities of great economic importance.

However, there has been much debate as to the nature of the size of the entity for which these standards should be written within the definition of NPAEs. We are concerned that this has risked the main direction of the project being towards standards which will meet the needs of larger unlisted entities, and away from the needs of the vast bulk of NPAEs which are SMEs.

In responding to this consultation we take the view that it is not relevant or productive to focus on the appropriate size of entity because of global variations in terms of the perception of the size of entities. For example, what is considered a small firm in the US is likely to be very different from that in, say, Uganda. Instead our response to the consultation focuses on users of financial reports of NPAEs. This is, because the user perspective is based on a well argued case for differential reporting. The needs of users of the general purpose financial statements of NPAEs will be largely independent of size.

We consider the main external users that should be catered for to be lenders, shareholders, trading partners and employees. The needs of shareholders are rightly given priority in developing IFRS, but they should be given less importance in SME standards because external shareholders will be less common and their perspective in using the information more in the assessment of the long term performance of management than in shorter term buy-sell-hold decisions. Users in a SME environment generally require less complex and less sophisticated financial reporting than users of listed entity financial reports.

The elimination of options

There are a number of optional treatments within full IFRS. While these add to the length of the standards in terms of pages of text we would not favour their elimination in the SME standards in general for four main reasons.

• We see no reason why accounting options such as the capitalisation of interest in the construction cost of assets should be permitted for large listed companies but denied to SMEs. These options reflect genuine unresolved issues in financial reporting or differing economic or business conditions around the world.
• We also foresee that the main role that IASB’s SME standards will play is as a blueprint for national authorities to adapt and issue as national standards. Certain options inappropriate for national circumstances will be eliminated in this way, but the eliminations may be different from country to country.
• A key argument against options is the loss of comparability. Absolute comparability of reporting is a less significant factor for the SME standards than for full IFRS. The users of SME accounts are less likely to need to compare financial statements across national boundaries than are global investors in listed companies.
• Options as such are not a burden in terms of compliance costs.

The use of fair value

We support the notion that in the SME environment the trade-off between the relevance of fair values and the reliability of those values will be different than for listed companies.

Fair values may be needed to be used where costs are not available or where an overall cost needs to be apportioned on a rational basis across a number of assets or liabilities. Otherwise in the SME standards fair values of assets should only be used where both:

• observable market data is available and
• the asset can be sold without disruption to the entity’s main operations.

Q1. Recognition and measurement differences

IFRS1 First time application

This issue will exist for the SME standards as much as for full IFRS. The principles of restatement of comparative figures should apply. The exceptions to those – mandatory and optional – would have to be considered in the light of the standards that are agreed to be applied to SMEs.

IFRS2 Share based payments

Share based payments while not normal, will not be rare for SMEs. The general principles should be carried through to SME, however given the unlisted status of their securities fair value may commonly be hard to reach. The text of IFRS2 includes some help in application for unlisted entities and specifically allowing the intrinsic valuation method when “in rare cases” fair values are hard to show. The SME standards should include intrinsic valuation as the expected norm but with fair values used when this is possible.

IFRS3 Business combinations

For SMEs we would favour largely a return to the accounting treatment that was previously established under IAS22. The impairment only model of IFRS3 produces significant costs of compliance for preparers and the benefits to users of SME reports of the new information seems debatable, given that it does not affect much the shorter term cash flow position that is often their focus. We accept that goodwill amortisation over useful lives up to 20 years does not produce very directly relevant information either. Compliance costs, however, would be reduced and the purchase price would be accounted for in a similar way whatever its component parts (tangible assets, goodwill or other intangibles).

We would propose that SMEs should be offered the option of either:

• amortisation over useful lives up to 20 years with impairment only when there is some indicative trigger, or
• a no amortisation, but annual impairment test model deriving from IFRS3.

If the above amortisation option were taken up by an SME we consider there should be scope for significantly reducing the obligation for the separate recognition of intangible assets on acquisition and of the fair valuation exercise. This is again an area where the benefits to the users of SME accounts of this information seem hard to gauge, in contrast to the known high compliance costs.

IFRS5 Assets held for disposal

This standard largely concerns presentation and disclosure issues. We do not consider that its provisions on measurement are needed in SME standards, as the key effects will be achieved by impairment testing triggered by the intention to dispose of the asset or business.

IFRS6 Exploration costs

We see no reason to change any of the limited number of recognition and measurement requirements of this standard in preparing SME standards.

IAS2 Inventories

The full cost method of including all appropriate conversion costs in the value of inventories should not be modified for SMEs. We also see no reason for giving SMEs the option to use the LIFO method of cost attribution.

IAS8 Accounting policies and the correction of errors

We would make no change to the principles in this standard. We consider that the general principle of retrospective adjustment for errors and changes in accounting policy should apply to SMEs for example.

IAS10 Events after the balance sheet date

We see no reason to change any of the limited number of recognition and measurement requirements of this standard in preparing SME standards.

IAS11 Construction contracts

We would not propose any modification to the recognition and measurement requirements of this standard. The impact of not using the percentage of completion method on the financial statements of any construction company would be fundamental and could render meaningless the comparability of the results from one year to the next.

IAS18 Revenue

In a similar way we would see the recognition principles for service contracts as fundamental to accounts of any enterprise engaged in such a business.

We see no reason either to modify the principles for recognising the sales of goods.

IAS12 Taxation

We disagree with including deferred tax accounting for SMEs. Our reasons relate primarily to user needs and the understandability of the accounts.

Users of SME accounts are more interested in shorter term cash flows and the ability to meet current obligations. Deferred tax provisions and assets are more helpful when considering the longer term generation of cash flows and trends in the tax charges. Deferred tax balances do not represent current assets or obligations of the entity and at best represent contingencies.

As an alternative to deferred tax accounting, disclosures might just as effectively give the users the information that some of them require in this regard. Disclosures of (a) current factors which might have significant effects on future tax rates (b) tax liabilities that might crystallise on the disposal of revalued assets might be more appropriate substitutes. In order to meet the requirement of (a) preparers should not in effect have to carry out a deferred tax calculation. It would highlight significant factors which might cause the tax rates in future to be higher or lower.

We do not believe that most users of SME accounts understand what deferred tax represents.

IAS17 Lease accounting

We consider that the recognition and measurement requirements in the full IAS17 should be retained for lessors either in the SME standards or dealt with via a mandatory fall back.
For lessees we would not include the recognition and measurement of finance leases. Our reasons are on the basis of the needs of users and it is not clear that the compliance cost for preparers would be worthwhile in terms of benefits to users.

The main justification for IAS17’s approach is that assets where the lessee has in substance rights equivalent to ownership, are otherwise missing from the balance sheet. The users of SME accounts, however, are less likely to be using returns on capital measures for performance that would benefit from IAS17’s partial capitalisation of leased assets. Creditors and others are, indeed, as likely to be misled by the presence of assets in the balance sheet that are not owned by the company and not available to meet general liabilities.

In our experience the users of SME accounts are however interested in the unavoidable obligations of the entity. IAS17 shows those under leases partly on the balance sheet as liabilities (finance lease obligations) and partly as a disclosure note to the financial statements (operating lease commitments). The users would find clearer a comprehensive disclosure of the commitments under all leases and the time period for which they extend into the future.

IAS19 Employee benefits

We would make no recognition and measurement difference for SMEs in this area, even in respect of defined benefit pension and other post-employment commitments which are the most complex part of the standard. We note that employees and their representatives are potential users of the accounts of SMEs and they should have the information on this basis. Though IAS19 contains significant options for the different recognition of actuarial variations, we would leave those options in place in the SME standards for the reasons given among our general remarks. National authorities could eliminate some of these in applying the SME standards in their jurisdiction.

IAS27 Consolidation of subsidiaries

The principle of the consolidation of the results and financial position of an entity and all other entities that are controlled by it, should be retained for SMEs. The difference between the consolidated financial statements and those of the individual entity often gives fundamentally different results.

IAS27 includes an option for the investment in subsidiaries in an entity’s separate financial statements to be stated either at cost or at fair value. This option should be retained for SMEs.

IAS28 and 31 Associates and joint ventures

Equity accounting should be retained in both these standards when they are applied by SMEs. The effects of incorporating associates and joint ventures (JVs) can be fundamental (see our comments on consolidation of subsidiaries above). The option for proportional consolidation of JVs should remain.

IAS36 Impairment

As noted above we consider that the impairment-only model for goodwill and indefinite life intangible assets from IFRS2 should not be a requirement, but only an option for SMEs. The special impairment provisions for such assets under IAS36 would not therefore be needed in other cases.

The general principle of impairment is an important one. We do not think that any of the other recognition and measurement principles in IAS36 should be adjusted. We consider for example that the concept of discounting future cash flows to net present value is reasonably well understood and it is not onerous to perform. There would be scope for making the calculation more straightforward – for example guidance in reaching an appropriate discount rate. The pre-tax risk adjusted rate required in IAS36 may be difficult to translate into practice for SMEs.

IAS37 Provisions and contingencies

As with IAS36 we would transfer the main principles of IAS37 across into SME standards, but would make similar observations about discounting.

IAS38 Intangibles

The capitalisation of development costs as intangible assets when the various criteria are met is important for SMEs and should not be altered. Intangibles are likely to be an increasing proportion of assets generally. In new and developing SMEs, intangibles can be a significant factor compared to a well-established listed company with a regular pipeline of product development feeding through.

As noted above we would propose a change in accounting for goodwill between SME standards and full IFRS and this would apply to other indefinite life intangibles as well.

IAS39 Financial instruments

We consider there is scope for simplification of the recognition and measurement rules in IAS39, but are aware that the establishment of an alternative system would need to be fully worked through. The basic lines along which a simpler standard could be established would be as follows.

• Two main classes of financial assets – those readily realisable in an active market should be stated at fair value with changes through the income statement. All others should be at amortised cost, subject to impairment.
• All liabilities to be at amortised cost.
• Hedge accounting to be relaxed so that designation and effectiveness testing would be an exercise carried out at the end of each reporting period. For hedges of forecast transactions the derivatives would not need to be stated at fair value, but unavoidable losses would need to be provided for.

For SMEs there should be a requirement to disclose the approach to the entity’s management of financial risks and the role of derivatives in that.

There would be scope for simpler presentation of the requirements of IAS39. The treatment of the more common financial instruments such as trade receivables, loans and listed investments could be set out separately from the more complex, but more rarely occurring items. Given that financial institutions are generally scoped out from the definition of SMEs, this would help to eliminate some of the complexities.

Other standards where no change proposed

No change in the main recognition and measurement requirements would be proposed, other than those set out above, for the following standards.

• IAS20 Foreign currency translation.
• IAS29 Hyperinflation.
• IAS40 Investment property.
• IAS41 Agriculture.

Q2. Topics to be omitted on the grounds that they would be unlikely to occur

Certain standards would be essentially not mandatory for SMEs as defined in the tentative decisions of the IASB. SME versions of these need not be included, which we consider means the following.

• IFRS4 Insurance contracts.
• IAS14 Segment reporting.
• IAS26 Retirement benefit plans.
• IAS30 Disclosures by banks etc.
• IAS33 Earnings per share.
• IAS34 Interim financial reporting.

As long as would be a mandatory fallback to full IFRS where a topic is not covered by the SME standards, then we would not support omitting any other standards from the SME list. All the standards will all be applicable to some SMEs and a mandatory fall back might be to an inappropriate accounting treatment.

As we stated in our earlier response we do not support mandatory fall back, but would support reference back to full IFRS as a source of guidance or best practice. This would have the advantages of

• eliminating the need for SME standards on relatively uncommon transactions to be included
• without imposing full IFRS where this would really be inappropriate.

 

Back to top