An International Financial Reporting Standard for SMEs Paul Pacter IASB Director of Standards for Small and Medium-sized Entities CReCER Regional Conference on Accounting & Auditing Mexico City 13 June 2007 1 Why SME Standards Are Needed Benefits of global accounting standards for listed companies are obvious in globalised financial markets. Global standards are also needed for unlisted SMEs: Banks use financial statements to make lending decisions. Banks and regulators need information to monitor their credit risks after loan is made. Vendors evaluate finances of buyers. 2 1
Why SME Standards Are Needed Global standards are also needed for unlisted SMEs (continued): Credit rating agencies and banks that provide rating services. Overseas customers. Foreign venture capital. Development institutions. 3 Why SME Standards Are Needed Benefits of global SME standards go beyond comparability: Improved quality of reporting as compared to existing GAAP Ease burden on SMEs where full IFRSs or full national GAAP are now required for SMEs Education and training Auditing efficiencies 4 2
IASB Exposure Draft IASB has issued an Exposure Draft of an IFRS for SMEs. Simplified, self-contained set of accounting principles for SMEs. Makes IASB accounting requirements more accessible to preparers in both developed and emerging markets. Reduces burden to prepare SME financial statements. 5 IASB Exposure Draft Approach to IFRS for SMEs: Based on full IFRSs, which are developed for public capital markets. Modifications based on user needs and cost-benefit. Enables investors, lenders, others to compare SMEs financial performance, financial condition, and cash flows. 6 3
IASB Exposure Draft Approach to IFRS for SMEs: Organised by topic. Plus illustrative financial statements, disclosure checklist, and basis for conclusions. Posted on IASB website 15 February 2007. Comment deadline 1 October 2007. 7 IASB Definition of SME IASB view: IFRS for SMEs is appropriate for an entity with no public accountability: not publicly traded; and not a financial institution. Entity whose securities are publicly traded has public accountability. Need full IFRSs for investor protection. Even if small in size. 8 4
IASB Definition of SME No quantified size test: Each jurisdiction should develop guidelines on which entities will use the IFRS for SMEs. Could include quantified size test. Jurisdiction could say that companies above the size threshold (even if unlisted) must use full IFRSs. 9 IASB Definition of SME In developing the ED, IASB focused on a typical SME with about 50 employees in deciding the content of the IFRS for SMEs. IFRS for SMEs addresses issues such an SME typically encounters. Simplifications were based on user needs and cost/benefit tradeoffs for a company of that size. But this is not intended as a size test. Applicability is up to each jurisdiction. 10 5
IASB Approach General purpose financial statements for external users, including: Non-manager owners. Existing and potential lenders and creditors. Credit rating agencies. Auditor could give opinion on fair presentation (true/fair view) of financial position, results, cash flows. 11 IASB Approach Stand-alone document: SME must try to find answers in the IFRS for SMEs: by analogy, and by using pervasive principles in first section of IFRS for SMEs. SME may look to full IFRSs if answer cannot be found in the IFRS for SMEs. But, no mandatory fallback to full IFRSs. 12 6
IASB Approach Simplifications based on user needs and cost-benefit: 1. Some topics in IFRSs not included if irrelevant to SME. 2. Where IFRS has options, include only simpler option. 3. Recognition and measurement simplifications. 4. Reduced disclosures. 5. Simplified drafting. 13 IASB Approach Material not relevant to typical SME omitted, with crossreferences to full IFRSs if needed: Hyperinflation. Equity-settled share-based payment. Determining FV of agricultural assets. Extractive industries. Interim reporting. Lessor finance leases. 14 7
IASB Approach Only simpler of options in full IFRS are included. Other(s) cross-referenced. So, only: Cost for investment property. Cost for PP&E and intangibles. Expense all borrowing costs. Indirect operating cash flows. One method for all grants. Jurisdictions could eliminate options. 15 IASB Approach Recognition and measurement simplifications, page 1 of 2: Financial instruments: Two classifications, not four. Drop continuing involvement approach for derecognition. Much simplified hedge accounting. Goodwill impairment indicator approach. Expense all R&D. Cost method for associates and JVs. Income taxes simplified method. 16 8
IASB Approach Recognition and measurement simplifications, page 2 of 2 Less fair value for agriculture only if readily determinable without undue cost or effort. Defined benefit plans principle approach, no corridor tests. Share-based payment intrinsic value. First-time adoption less prior data. Leases simplified calculations. 17 Other Issues Suitability for micro-smes (tiny) Yes, definitely. The issue is whether micro prepares general purpose financial statements that present fairly position, performance, and cash flows. Full IFRSs are required for micros in about 25 countries and permitted in another 50 countries. 18 9
Other Issues Suitability for tax returns, dividend distribution, other legal requirements? For managing the business? These are not specific objectives of the IASB. However, with a simple reconciliation developed country by country, IFRS for SMEs can be the basis for tax or legal reporting. We believe the information will likely be useful for managing. But our goal is external financial reporting. 19 Other Issues IASB did not consider developing a very brief (say 20-page) standard for micros (as some people propose): It would only have broad accrual basis principles. Cover only limited transactions. Perhaps require only a balance sheet and income statement, limited notes. Financial report would not meet users needs for information. Would not help SME raise capital. 20 10
Simplifications Considered but Not Adopted Drop the cash flow statement. All leases operating. All pension plans defined contribution. Completed contract only. Fewer provisions. Non-recognition of share-based payment. Non-recognition of deferred taxes. Cost model for all agriculture. No consolidation. Derivatives at cost. 21 The Effort: Due Process Comprehensive due process, including: Discussion paper (June 2004). Recognition and measurement (R&M) questionnaire (April 2005). Public roundtables on R&M (Oct. 2005). Working Group (35 members). Deliberations at over 30 Board meetings. Roundtables on ED (ongoing). 22 11
Maintenance Maintaining the IFRS for SMEs: Update the IFRS for SMEs every 2 years if needed. Omnibus Exposure Draft. 23 Exposure Draft Board vote to issue the ED: 13 to 1 Comment deadline 1 October 2007. French, Spanish, German translations April 2007. ED 254 pages Implementation Guidance 80 pages Model financial statements Disclosure checklist Basis for Conclusions 48 pages 24 12
Exposure Draft Invitation to comment at front of the ED raises 11 questions. Of course, comments are invited on any issues in the ED. 25 Exposure Draft Next steps: Continued roundtables with SMEs, small audit firms, and national standard setters. Field tests and/or visits to SMEs. Final Standard 2H 2008. Effective whenever adopted locally. 26 13
CReCER Countries Can Help Us! Comments on the ED: How to disseminate the ED to SMEs and small audit firms in your jurisdiction? They generally do not get involved in IASB proposals. Respond to ED and encourage your constituents to respond. 27 CReCER Countries Can Help Us! We welcome your critique of the ED. We want to know: Have we taken out too much from IFRSs? What s missing? Not enough? What else? Did we get it about right? Does it meet your information needs? Is more implementation guidance needed? 28 14
CReCER Countries Can Help Us! Consider whether and how the IFRS for SMEs could be adopted in your jurisdiction: Which companies? Are there unique local issues that should be addressed? Relationship with existing SME standards? Possible timing of transition? 29 Thank you. Questions? Comments? EXPRESSIONS OF INDIVIDUAL VIEWS BY MEMBERS OF THE IASB AND ITS STAFF ARE ENCOURAGED. THE VIEWS EXPRESSED IN THIS PRESENTATION ARE THOSE OF DR. PACTER. OFFICIAL POSITIONS OF THE IASB ON ACCOUNTING MATTERS ARE DETERMINED ONLY AFTER EXTENSIVE DUE PROCESS AND DELIBERATION. 30 15