IFRS: as IFRSs have grown in detail, so has the burden on SMEs. Rob Mackay finds out whether the new simplified IFRS book will ease the load.
Should SME be an acronym for a Significant Migraine Emerging? That was what I was left pondering having recently undertaken the Australian field testing for the proposed IFRS for SMEs accounting standard.
While the IASB's main objective was to reduce the SME accounting burden associated with compliance with the full book of IFRS, it is apparent that there is still going to be a need for people with some significant IFRS experience to handle the interpretation and implementation of the SME accounting requirements if they are released in their present form.
Honey, I shrunk the standards!
The reduction in size of the full book to the 'IFRS lite' version of about 250 pages has been primarily achieved in two ways. Firstly, topics that the IASB considered would not typically be encountered by an SME have been omitted. Secondly, much of the lengthy discussion around key concepts and application guidance has been dropped in the hope that plainer English is an adequate substitute.
The streamlined standard is, in the main, easier to read. However, some of the more complicated areas of accounting such as financial instruments, tax effect accounting and business combinations would appear to have suffered.
The SME hierarchy
In the absence of specific guidance on a particular accounting issue, the draft standard directs the user to a tiered hierarchy to allow the selection of an appropriate accounting policy. The first point of reference in this hierarchy is the SME's own accounting framework of pervasive concepts.
However, to apply the framework to solve an accounting dilemma will require the judgement of an accountant who is more than familiar with IFRS. If the user can't come to what they consider an appropriate conclusion using the framework, the big book of IFRS may then be consulted.
Practical problems in accounting for issues not specifically addressed
For the areas not covered in the SME standard, those accountants familiar with the full IFRS may end up asking themselves: 'Is the omission of specific guidance a deliberate attempt by the IASB to simplify accounting or is it simply based on trying to keep the small book small?'
Example 1
On the topic of intangible assets acquired in a business combination, there is an absence of guidance on the types of intangibles that might be recognised, as well as no detail on fair value measurement considerations. This may be seen as tantamount to an invitation to avoid the inherent difficulties associated with having to account for such assets.
After all, referring to the SME framework is unlikely to assist a user to identify whether an entity has just acquired an intangible asset such as a 'usage right', 'favourable lease' or 'customer relationship'. It is also not going to assist in its measurement. Allocating additional value to goodwill is therefore a far more attractive outcome.
On the other hand, while referral to the full IFRS is not mandatory, a practitioner may feel a sense of duty to use AASB 138 and opt for consistency under the SME standard unless told otherwise.
Example 2
Under the full book of IFRS, the many entities that provide letters of credit, bank guarantees, or that enter into deeds of cross guarantee are required to recognise and carry a financial liability at fair value, at least to the extent that it is material. The valuation of such liabilities can be considered a fairly onerous exercise at times. Prior to the inclusion of a specific reference to 'financial guarantees' in AASB 139 from 1 January 2006, these liabilities were generally not recognised by entities.
Yet there is not a single mention in relation to the recognition requirements of financial guarantees in the SME standard. Relying solely on the SME framework, it may seem quite feasible for an SME to argue that the liability simply can't be measured reliably without unreasonable cost, and therefore the liability should not be recognised.
SME not a replacement for the full book
It is the intention of the SME standard to essentially be a stand-alone document with minimal reference to the full book of IFRS.
However, in the absence of specific guidance on issues such as those in the above examples, it is expected that accountants and auditors will, in practice, be forced to refer to the full book of IFRS to ascertain appropriate accounting.
This may be even more so in the Australian environment considering that the AASB is currently proposing to apply the SME standard to entities with turn-over and assets up to $500 million and $250m respectively. It is not difficult to imagine the potential complexity of transactions that such entities would enter into on a not-too-infrequent basis and the consequent need for some detailed guidance.
Other example hotspots
Other examples of specific issues that were noted during our field testing included:
Simpler recognition and measurement The requirement for changes in accounting policies are said to lead to relevant and more reliable information, but is it actually possible for an SME to adopt any simpler accounting available under the proposals if full IFRS recognition and measurement principles have previously been applied? Would an entity elect to adopt a simpler policy if it has the effect of eroding earnings? For example, moving from equity accounting of an associate to a cost method or expensing of development costs that were previously capitalised would be detrimental to the balance sheet.
Tax effect accounting AASB 112 discusses the offsetting of deferred tax assets (DTA) and deferred tax liabilities (DTL). Such reference is not included in the SME standard. The SME standard includes a statement that an entity shall not offset assets and liabilities unless required or permitted by the standard. Is offsetting DTAs and DTLs strictly prohibited? Or perhaps it is possible to argue that an entity could rely on the framework to conclude that a DTL in those circumstances is not actually a liability? Without some additional guidance, the tax accounting requirements pertaining to the initial recognition of assets and liabilities could be incomprehensible to even those accountants with a sound IFRS knowledge.
Business combinations In the absence of guidance on provisional accounting, it would seem possible that an entity could continue to make adjustments to the consideration paid and / or the fair value of net assets acquired into the future without restriction. There is also an absence of guidance relating to deferred consideration which could lead to some uncertainty as to an appropriate measurement basis.
Financial assets and liabilities It is unclear when receivables and payables and loans to and from subsidiaries meet, or don't meet, the requirements for measurement at amortised cost. A loan receivable with deferred settlement and a zero (or below market) interest rate would appear capable of satisfying the requirements for measurement at amortised cost. Rather than being initially recognised at fair value as required by full IFRS, the zero rate receivable is initially recognised at historical cost, being the amount of the advance. Under the required effective interest rate method (which gives a rate of 0 per cent), the subsequent measurement of the loan would continue to be equivalent to its notional outstanding balance.
As such, there is no discounting of the receivable to present value, which seems inconsistent with other elements of the SME financial report dealing with deferred settlement.
Where an entity makes an election to adopt AASB 139, it may utilise the 'available for sale' classification for financial assets. However, investments in subsidiaries must remain classified at either cost or 'fair value through profit or loss' according to the SME standard. It seems possible therefore to have a divergent treatment of similar financial assets carried at fair value in the parent entity accounts.
Leases In the absence of specific mention, should an SME's lease incentives be included in the straight-lining of rent expense (as per full IFRS) or is there another appropriate way of accounting for them under the SME framework?
Share-based payments In relation to equity-settled share-based payments, the IASB suggests that there is a level of simplification already available to SMEs because IFRS 2 (or AASB 2, which the SME must refer to) already contains an allowable measurement at intrinsic value where the entity is unable to estimate reliably the instrument's fair value. However, AASB 2 suggests that the inability to estimate a reliable fair value would be 'rare'. Valuation models to determine fair value are likely to still be required. It must also be considered that an intrinsic value model would require a valuation to be conducted on the SME's shares in any event. It is difficult to see any simplification here.
Increased workload and risk? In practice, the SME standard may not simplify the workload of the accountant or auditor as it currently stands. There is a danger that, as internal quality and risk management teams of the larger accounting firms move to cover all bases, the SME framework could end up being the first level of compliance of a dual accounting framework system for SME entities.
For the accounting firms that take the SME standard at face value, could they be exposing themselves to risks of professional negligence if they ignore the requirements of full IFRS?
Non-reporting entities It is likely that a non-reporting SME will see additional disclosures appear in their financial report under the SME standard. This may have impacts on accounting and audit costs for the inclusion of additional disclosures, the usefulness of which may be questionable. The disclosure requirements of the SME standard have been criticised by many participants in the SME debate, and this is at least an area that is likely to be subject to some change.
Time for a rethink?
It is probably near impossible to simplify something as complex as the full book of IFRS into a short self-contained document without creating some confusion in the process.
While the SME project has been written with SME users in mind, it is likely that the same accountants that apply the full book of IFRS are going to need to come into play for their smaller sibling. Interpretation of the full book is still evolving. Previously settled positions on various complex accounting issues are often reopened for debate with new outcomes concluded.
The issue and application of new accounting standards is also just around the corner and likely to trigger new cycles of debate around implementation. With this in mind, it may be time for the standard setters to park their SME project for a while until the dust settles on the full book of IFRS. If not, then there are likely to be many accountants reaching for the headache tablets.
Rob Mackay is an associate director and head of technical accounting services at Moore Stephens in Melbourne.
