Contents

In June 2004 the Board published a discussion paper Preliminary Views on Accounting Standards for Small and Medium-sized Entities setting out and inviting comments on the Board’s approach. This was the first discussion paper that the IASB published. The Board received 120 responses.

The major issues set out in the discussion paper were:

At its meetings later in 2004, the Board considered the issues raised by respondents to the discussion paper. In December 2004 and January 2005, the Board made some tentative decisions on the appropriate way forward for the project. The responses to the discussion paper showed a clear demand for an International Financial Reporting Standard for SMEs (IFRS for SMEs) and a preference, in many countries, to adopt the IFRS for SMEs rather than locally or regionally developed standards. The Board therefore decided to publish an exposure draft of an IFRS for SMEs as the next step.

Most respondents to the discussion paper said that simplifications of the principles for recognising and measuring assets, liabilities, income and expenses were needed, but few specifics were proposed. And when some specifics were proposed, the commentators generally did not indicate the particular transactions or other events or conditions that create the recognition or measurement problem for SMEs under IFRSs or how that problem might be solved.

The IASB concluded that it needed further information to assess possible recognition and measurement simplifications. Consequently the Board decided to hold public round-table meetings with preparers and users of the financial statements of SMEs to discuss possible modifications of the recognition and measurement principles in IFRSs for use in an IFRS for SMEs. The Board instructed the staff to develop and publish a questionnaire as a tool to identify issues that should be discussed at those round-table meetings.

The questionnaire, published April 2005, asked two questions:

The Board received 101 responses to the questionnaire. Those responses were discussed with the Standards Advisory Council (June 2005), with the SME Working Group (June 2005), World Standard-Setters (September 2005) and at the public round tables held by the Board in October 2005. A total of 43 groups participated in the round-table discussions with the Board over a two-day period.

The IASB’s working group met in June 2005 and made a comprehensive set of recommendations to the Board regarding the recognition, measurement, presentation and disclosure requirements that should be included in an exposure draft of an IFRS for SMEs. Later in 2005, the Board considered those recommendations and the views expressed in the responses to the discussion paper and the questionnaire, and at the round tables. During those deliberations, the Board made tentative decisions about the requirements to be included in the exposure draft.

On the basis of those tentative decisions, at the Board meeting in January 2006 the staff presented a preliminary draft of the exposure draft. The working group met in late January 2006 to review that draft and prepared a report of its recommendations for the Board’s consideration. The Board’s discussion of the draft began in February 2006 and continued throughout the remainder of 2006. Revised drafts of the exposure draft were prepared for each Board meeting from May onwards. From July 2003 until the exposure draft was published in February 2007, the issues were deliberated by the Board at 31 public Board meetings.

To keep constituents informed and help them begin planning their responses, a complete staff draft of the exposure draft was posted on the IASB’s website in August 2006. A revised staff draft was posted on the IASB’s website in November 2006.

In February 2007 the IASB published for public comment an exposure draft of a proposed IFRS for SMEs. The aim of the proposed standard was to provide a simplified, self-contained set of accounting principles that are appropriate for smaller, non-listed entities and are based on full IFRSs, which are developed to meet the needs of entities whose securities trade in public capital markets.

The proposed standard was based on full IFRSs with modifications to reflect the needs of users of SMEs’ financial statements and cost-benefit considerations. The exposure draft proposed five types of simplifications of full IFRSs:

Primarily because of (a) and (b) above, the proposed IFRS for SMEs would not be a stand-alone document.

Along with the exposure draft, the IASB published and invited comment on proposed implementation guidance consisting of a complete set of illustrative financial statements and a disclosure checklist. The exposure draft was accompanied by a basis for conclusions that explained the Board’s reasoning in reaching the conclusions in the exposure draft.

The exposure draft was translated into five languages (a first for the IASB), and the translations were posted on the IASB’s website. The IASB also published a staff summary of the exposure draft to help constituents get an initial understanding of the proposals, also posted on the IASB’s website.

Comments on the exposure draft were initially due on 30 September 2007, but the Board extended the deadline to 30 November 2007 primarily at the request of field test participants.

With the help of national standard-setters and others, the IASB completed a field test programme that involved 116 small entities from 20 countries. About 35 per cent had ten or fewer full-time employees. A further 35 per cent of the entities in the sample had between 11 and 50 full-time employees. Over half of the entities had bank loans or significant overdrafts. A third had foreign operations.

The goals of the field testing were:

To help the field testers and others in applying the exposure draft, the IASB published a compliance checklist for the exposure draft that was developed by one of the international accounting firms.

The field test questionnaire was posted on the IASB’s website in June 2007 in English, French and Spanish. Field test entities were asked:

A report of the field tests was provided to Board members and posted on the IASB’s website. The main factor influencing the type of problems identified by field testers was the nature and extent of differences between the IFRS for SMEs and an entity’s existing accounting framework.

About half of the field test entities identified no, or only one or two, issues or problems. The three main issues identified by field testers were the following:

The Board received 162 letters of comment on the exposure draft. All letters were made available to Board members and posted on the IASB’s website. Paragraphs BC36⁠–⁠BC158 discuss the Board’s reasoning on the chief technical issues in the project. Here is a brief summary of the main issues raised in the letters of comment on the exposure draft:

The Board began its redeliberations of the proposals in the exposure draft in March 2008. Those redeliberations continued until April 2009―a total of 13 public Board meetings―bringing to 44 the total number of public meetings at which the Board deliberated the IFRS for SMEs.

At the Board’s meeting in March 2008, staff presented an overview of the main issues (other than disclosure issues) raised in the comment letters on the exposure draft (see paragraph BC26). At the Board’s next meeting in April 2008, staff presented an overview of the main issues that were identified as a result of the programme for field testing the exposure draft (see paragraph BC25). Both of those meetings were educational in nature, and the staff did not raise any issues for decision.

The IASB’s working group met on 10 and 11 April 2008. The recommendations of working group members on each issue (other than disclosure) that was discussed at that meeting were presented to the Board at the Board’s meeting in May 2008. Recommendations of working group members relating to disclosure were presented to the Board in an agenda paper at the Board’s meeting in July 2008. The reports of the working group’s recommendations were posted on the IASB’s website.

In May 2008, the Board began to redeliberate the proposals in the exposure draft by addressing issues relating to scope, recognition, measurement and presentation that were raised in the letters of comment on the exposure draft, in the reports prepared by field test entities and in the recommendations of the working group. Those redeliberations continued until February 2009. A list of the main changes made as a result of those redeliberations is presented in paragraph BC34.

In March 2009 the Board considered the changes made during its redeliberations of the exposure draft in the light of the guidelines for re-exposure in the Due Process Handbook for the IASB. The Board concluded that the changes made did not warrant re-exposure.

The project was discussed with the Standards Advisory Council at seven of its meetings. The issues in the project were also discussed at five of the annual meetings of the World Accounting Standard-Setters hosted by the IASB from 2003 to 2008. The working group met four times to discuss the issues and provide advice to the Board. A joint working party of the European Financial Reporting Advisory Group (EFRAG) and the European Federation of Accountants (FEE) was particularly helpful in providing guidance to the staff.

The Board recognised that, typically, SMEs and their auditors and bankers have not participated in the IASB’s due process. With the objectives of encouraging such parties to become familiar with the IASB and to consider and respond to the exposure draft, the staff undertook a comprehensive outreach programme on this project. That programme entailed presentations at 104 conferences and round tables in 40 countries, including 55 presentations after the exposure draft was published. The IASB also explained the exposure draft and responded to questions in two public webcasts for which nearly 1,000 participants registered. In April 2007 a staff overview of the exposure draft, in question-and-answer format, was posted on the IASB’s website. The purpose of the overview was to provide an introduction to the proposals in non-technical language.

The main changes from the recognition, measurement and presentation principles proposed in the exposure draft that resulted from the Board’s redeliberations were:

This Basis for Conclusions sets out the main issues addressed by the Board, the alternatives considered, and the Board’s reasons for accepting some alternatives and rejecting others.

In deciding to develop an IFRS for SMEs, the IASB was mindful of the following issues:

The Framework (paragraph 12) states:

The objective of financial statements is to provide information about the financial position, performance and changes in financial position of an entity that is useful to a wide range of users in making economic decisions.

In establishing standards for the form and content of general purpose financial statements, the needs of users of financial statements are paramount.

Users of financial statements of SMEs may have less interest in some information in general purpose financial statements prepared in accordance with full IFRSs than users of financial statements of entities whose securities are registered for trading in public securities markets or that otherwise have public accountability. For example, users of financial statements of SMEs may have greater interest in short-term cash flows, liquidity, balance sheet strength and interest coverage, and in the historical trends of profit or loss and interest coverage, than they do in information that is intended to assist in making forecasts of an entity’s long-term cash flows, profit or loss, and value. However, users of financial statements of SMEs may need some information that is not ordinarily presented in the financial statements of listed entities. For example, as an alternative to the public capital markets, SMEs often obtain capital from shareholders, directors and suppliers, and shareholders and directors often pledge personal assets so that the SMEs can obtain bank financing.

In the Board’s judgement, the nature and degree of the differences between full IFRSs and an IFRS for SMEs must be determined on the basis of users’ needs and cost-benefit analyses. In practice, the benefits of applying accounting standards differ across reporting entities, depending primarily on the nature, number and information needs of the users of their financial statements. The related costs may not differ significantly. Therefore, consistently with the Framework, the Board concluded that the cost-benefit trade-off should be assessed in relation to the information needs of the users of an entity’s financial statements.

The Board faced a dilemma in deciding whether to develop an IFRS for SMEs. On the one hand, it believed that the same concepts of financial reporting are appropriate for all entities regardless of public accountability—particularly the concepts for recognising and measuring assets, liabilities, income and expenses. This suggested that a single set of accounting standards should be suitable for all entities, although it would not rule out disclosure differences based on users’ needs and cost-benefit considerations. On the other hand, the Board acknowledged that differences in the types and needs of users of SMEs’ financial statements, as well as limitations in, and the cost of, the accounting expertise available to SMEs, suggested that a separate standard for SMEs is appropriate. That separate standard could include constraints such as consistent definitions of elements of financial statements and focus on the needs of users of financial statements of SMEs. On balance, the Board concluded that the latter approach (separate standard) was appropriate.

The Board believes that the objective of financial statements as set out in the Framework is appropriate for SMEs as well as for entities required to apply full IFRSs. The objective of providing information about the financial position, performance and changes in financial position of an entity that is useful to a wide range of users in making economic decisions is applicable without regard to the size of the reporting entity. Therefore, standards for general purpose financial statements of entities with public accountability would result in financial statements that meet the needs of users of financial statements of all entities, including those without public accountability. The Board is aware of research that shows that over 80 jurisdictions currently require or permit SMEs to use full IFRSs.

IFRSs are designed to apply to the general purpose financial statements and other financial reporting of all profit-oriented entities. General purpose financial statements are directed towards the common information needs of a wide range of users, for example, shareholders, creditors, employees and the public at large. General purpose financial statements are intended to meet the needs of users that are not in a position to demand reports tailored to their particular information needs. General purpose financial statements provide information about an entity’s financial position, performance and cash flows.

Determining taxable income requires special purpose financial statements—ones designed to comply with the tax laws and regulations in a particular jurisdiction. Similarly, an entity’s distributable income is defined by the laws and regulations of the country or other jurisdiction in which it is domiciled.

Tax authorities are also often important external users of the financial statements of SMEs. Almost invariably, tax authorities have the power to demand whatever information they need to meet their statutory tax assessment and collection obligations. Tax authorities often look to financial statements as the starting point for determining taxable profit, and some have policies to minimise the adjustments to accounting profit or loss for the purpose of determining taxable profit. Nonetheless, global accounting standards for SMEs cannot deal with tax reporting in individual jurisdictions. But profit or loss determined in conformity with the IFRS for SMEs can serve as the starting point for determining taxable profit in a given jurisdiction by means of a reconciliation that is easily developed at a national level.

A similar reconciliation can be developed to adjust profit or loss as measured by the IFRS for SMEs to distributable income under national laws or regulations.

Owner-managers use SMEs’ financial statements for many purposes. However, it is not the purpose of the IFRS for SMEs to provide information to owner-managers to help them make management decisions. Managers can obtain whatever information they need to run their business. (The same is true for full IFRSs.) Nonetheless, general purpose financial statements will often also serve managers’ needs by providing insights into the business’s financial position, performance and cash flows.

SMEs often produce financial statements only for the use of owner-managers, or for tax reporting or other non-securities regulatory filing purposes. Financial statements produced solely for those purposes are not necessarily general purpose financial statements.

Public securities markets, by their nature, bring together entities that seek capital and investors who are not involved in managing the entity and who are considering whether to provide capital, and at what price. Although those public investors often provide longer-term risk capital, they do not have the power to demand the financial information they might find useful for investment decision-making. They must rely on general purpose financial statements. An entity’s decision to enter a public capital market makes it publicly accountable—and it must provide the outside debt and equity investors with a broader range of financial information than may be needed by users of financial statements of entities that obtain capital only from private sources. Governments recognise this public accountability by establishing laws, regulations and regulatory agencies that deal with market regulation and disclosures to investors in public securities markets. The Board concluded that, regardless of size, entities whose securities are traded in a public market should follow full IFRSs.

Similarly, a primary business of banks, insurance companies, securities brokers/dealers, pension funds, mutual funds and investment banks is to hold and manage financial resources entrusted to them by a broad group of clients, customers or members who are not involved in the management of the entities. Because such an entity acts in a public fiduciary capacity, it is publicly accountable. In most cases, these institutions are regulated by laws and government agencies.

In the discussion paper, the Board’s tentative view was that, in addition to the two conditions cited in paragraph BC56, an entity also has public accountability if it is a public utility or similar entity that provides an essential public service.

Most respondents to the discussion paper, and also the working group, pointed out that in many jurisdictions entities that provide public services can be very small—for example, refuse collection companies, water companies, local power generating or distribution companies, and local cable television companies. Respondents argued that the nature of the users of the financial statements, rather than the nature of the business activity, should determine whether full IFRSs should be required. The Board concurred.

In the discussion paper, the Board’s tentative view was that, in addition to the two conditions cited in paragraph BC56, an entity also has public accountability if it is economically significant in its home country on the basis of criteria such as total assets, total income, number of employees, degree of market dominance and nature and extent of external borrowings.

Most respondents, and the working group, argued that economic significance does not automatically result in public accountability. Public accountability, as that term is used in paragraphs 1.2 and 1.3, refers to accountability to those present and potential resource providers and others external to the entity who make economic decisions but are not not in a position to demand reports tailored to meet their particular information needs. The Board concluded that economic significance may be more relevant to matters of political and societal accountability. Whether such accountability requires general purpose financial statements using full IFRSs is a matter best left to local jurisdictions to decide.

In the discussion paper, the Board’s tentative view was that 100 per cent of the owners of a small or medium-sized entity must agree before the entity could use the IFRS for SMEs. The objection of even one owner of an entity to the use of the IFRS for SMEs would be sufficient evidence of the need for that entity to prepare its financial statements on the basis of full IFRSs. Most respondents did not agree. In their view, an objection, or even a non-response, by one or a few shareholders does not make an entity publicly accountable. They thought that the two criteria of (a) publicly traded and (b) financial institution appropriately identify entities with public accountability. The Board found those arguments persuasive.

In the discussion paper, the Board’s tentative view was that if a subsidiary, joint venture or associate of an entity with public accountability prepares financial information in accordance with full IFRSs to meet the requirements of the parent, venturer or investor, it should be required to comply with full IFRSs, not the IFRS for SMEs, in its separate financial statements. In the Board’s view, because the information in accordance with full IFRSs had been produced for other purposes, it would be more costly to prepare a second set of financial statements that comply with the IFRS for SMEs. Most respondents to the discussion paper did not agree. Many said that the IFRS data produced for consolidation or equity accounting purposes have a different materiality threshold from that necessary for the investee’s own financial statements. Moreover, they said that the circumstances of the entity, rather than the circumstances of its parent or investor, should determine whether it has public accountability. Consequently, they argued, it would be costly and burdensome for the investee to have to apply full IFRSs in its own financial statements. The Board found those arguments persuasive. Therefore, SMEs should assess their eligibility to use the IFRS for SMEs on the basis of their own circumstances, even if they also submit financial information in accordance with full IFRSs to a parent, venturer or investor.

Some respondents to the exposure draft proposed that a subsidiary whose parent uses full IFRSs, or is part of a consolidated group that uses full IFRSs, should be permitted to make the simplified disclosures required by the IFRS for SMEs but should be required to follow the accounting recognition and measurement principles in full IFRSs that are used by its parent if they are different from the accounting recognition and measurement principles in the IFRS for SMEs. Those holding this view thought that allowing the subsidiary to use the same recognition and measurement principles as its parent or its group would make consolidation easier.

The Board concluded, however, that the result would be, in effect, optional fallbacks to full IFRSs for a relatively small subset of entities eligible to use the IFRS for SMEs. The result would also be a hybrid set of accounting standards that is neither full IFRSs nor the IFRS for SMEs. That set of standards would differ for each such small or medium-sized entity depending on the accounting policies chosen by its parent or its group. The IFRS for SMEs is a standard appropriate for non-publicly accountable entities, not a ‘pick and choose’ set of options. A subsidiary of a full IFRS entity can always choose to follow full IFRSs in its separate statements. The Board concluded that if an entity’s financial statements are described as conforming to the IFRS for SMEs, it must comply with all of the provisions of that IFRS.

Because the IFRS for SMEs allows accounting policy choices for some recognition and measurement principles, differences from full IFRSs can be minimised by an entity’s accounting policy choices. The circumstances in which the IFRS for SMEs would mandate a recognition or measurement principle that is different from measurement under full IFRSs are limited. The following are the principal examples:

The definition of SMEs does not include quantified size criteria for determining what is a small or medium-sized entity. The Board noted that its standards are used in over 100 countries. The Board concluded that it is not feasible to develop quantified size tests that would be applicable and long-lasting in all of those countries. This is consistent with the Board’s general principle-based approach to standard-setting.

In deciding which entities should be required or permitted to use the IFRS for SMEs, jurisdictions may choose to prescribe quantified size criteria. Similarly, a jurisdiction may decide that entities that are economically significant in that country should be required to use full IFRSs rather than the IFRS for SMEs.

Some contend that it is unrealistic to design a single standard that could be used by all entities that do not have public accountability, because the size range of this group of entities is simply too broad―from very large unlisted entities with hundreds or even several thousand employees down to ‘micro-sized’ entities with fewer than ten employees. The Board did not agree. The IFRS for SMEs is designed for entities, regardless of size, that are required, or elect, to publish general purpose financial statements for external users. External users such as lenders, vendors, customers, rating agencies and employees need specific types of information but are not in a position to demand reports tailored to meet their particular information needs. They must rely on general purpose financial statements. This is as true for ‘micros’ as it is for larger SMEs. Financial statements prepared using the IFRS for SMEs are intended to meet those needs.

Some who question whether the IFRS for SMEs will be suitable for micros argue that many micro entities prepare financial statements solely to submit to income tax authorities for the purpose of determining taxable income. As explained more fully in paragraphs BC50⁠–⁠BC52, determining taxable income (and also determining legally distributable income) requires special purpose financial statements—ones designed to comply with tax and other laws and regulations in a particular jurisdiction.

Moreover, the Board noted that, in many countries, full IFRSs are required for all or most limited liability companies, including the micros. The Board also noted that many other countries permit the micros to use full IFRSs. As mentioned in paragraph BC48, over 80 jurisdictions have decided that full IFRSs should be required or permitted for all or most entities, including micros. If full IFRSs have been judged suitable for all entities, then the IFRS for SMEs will surely not be burdensome. The guidance in the IFRS for SMEs is clear and concise. That guidance may cover some transactions or circumstances that micro SMEs do not typically encounter, but the Board did not believe that this imposes a burden on micro SMEs. The topical organisation of the IFRS for SMEs will make it easy for micro SMEs to identify those aspects of the standard that are relevant to their circumstances.

Some favour a very simple and brief set of accounting requirements for micro SMEs—with broad principles of accrual basis accounting (some even suggest a cash basis or modified cash basis), specific recognition and measurement principles for only the most basic transactions, and requiring perhaps only a balance sheet and an income statement with limited note disclosures. The Board acknowledged that this approach might result in relatively low costs to SMEs in preparing financial statements. However, the Board concluded that the resulting statements would not meet the objective of decision-usefulness because they would omit information about the entity’s financial position, performance and changes in financial position that is useful to a wide range of users in making economic decisions. Moreover, the Board believed that financial statements prepared using such a simple and brief set of accounting requirements might not serve SMEs by improving their ability to obtain capital. Therefore, the Board concluded that it should not develop this type of IFRS for SMEs.

The IASB does not have the power to require any entity to use its standards. That is the responsibility of legislators and regulators. In some countries, the government has delegated that power to a separately established independent standard-setter or to the professional accountancy body. They will have to decide which entities should be required or permitted to use, or perhaps prohibited from using, the IFRS for SMEs. The Board believes that the IFRS for SMEs will be suitable for all entities that do not have public accountability, including micros.

Entities, large or small, whose debt or equity instruments are traded in public capital markets have chosen to seek capital from outside investors who are not involved in managing the business and who do not have the power to demand information that they might find useful. Full IFRSs have been designed to serve public capital markets by providing financial information especially intended for investors and creditors in such markets. Some of the principles in full IFRSs for recognising and measuring assets, liabilities, income and expense have been simplified in the IFRS for SMEs. Some of the disclosures required by full IFRSs are not required by the IFRS for SMEs. The Board concluded, therefore, that full IFRSs are appropriate for an entity with public accountability.

A jurisdiction that believes that the IFRS for SMEs is appropriate for small publicly traded entities in that jurisdiction could incorporate the requirements of the IFRS for SMEs into its national standards for small publicly traded entities. In that case, however, the financial statements would be described as conforming to national GAAP. The IFRS for SMEs prohibits them from being described as conforming to the IFRS for SMEs.

The accounting policy options mentioned in paragraph BC81(a) for which the exposure draft had included cross-references to full IFRSs have been dealt with in the IFRS for SMEs as follows:

The IFRS for SMEs does include one option for an entity to choose to follow a full IFRS, and that is the option to use IAS 39 Financial Instruments: Recognition and Measurement instead of Section 11 and Section 12. Otherwise, the final IFRS for SMEs is completely stand-alone—an entity applying it is not required to look to full IFRSs in addition to the IFRS for SMEs.

The exposure draft also proposed that if the standard does not address a transaction or other event or condition or provide a cross-reference back to another IFRS, an entity should select an accounting policy that results in relevant and reliable information. In making that judgement, an entity should consider, first, the requirements and guidance in the IFRS for SMEs dealing with similar and related issues and, second, the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses and the pervasive principles in Section 2 Concepts and Pervasive Principles of the draft standard. If that does not provide guidance, the entity may look to the requirements and guidance in IFRSs, including Interpretations of IFRSs, dealing with similar and related issues. This guidance remains in the IFRS for SMEs.

In addition to the complex options, the second type of mandatory cross-reference to full IFRSs proposed in the exposure draft related to topics addressed in full IFRSs but omitted from the IFRS for SMEs because they were not expected to be relevant for the majority of SMEs. To make the final IFRS for SMEs a stand-alone document, the Board decided to incorporate into the final IFRS for SMEs the following topics for which the exposure draft had proposed a cross-reference to full IFRSs:

Furthermore, the Board decided that the IFRS for SMEs should not address the following topics for which the exposure draft had proposed a cross-reference to full IFRSs:

Many commentators said that the requirements of IAS 39 are burdensome for SMEs. They cited as especially burdensome for SMEs the complexities of classifying financial instruments into four categories, the ‘pass-through’ and ‘continuing involvement’ tests for derecognition, and the detailed calculations required to qualify for hedge accounting. The Board agreed that simplifications of IAS 39 are appropriate for SMEs.

Much of the complexity in IAS 39 results from permitting entities to choose from a range of classification alternatives and measurement attributes for financial instruments. Those choices reduce comparability and impose measurement complexity. The IFRS for SMEs enhances comparability and reduces complexity by limiting the classification categories, specifying a measurement attribute and limiting the use of other optional measurement attributes.

Principal among the simplifications proposed in the IFRS for SMEs are the following:

With regard to hedge accounting, Section 12 requires periodic recognition and measurement of hedge ineffectiveness, but under less strict conditions than those in IAS 39. In particular, ineffectiveness is recognised and measured at the end of the financial reporting period, and hedge accounting is discontinued prospectively starting from that point, for hedges that no longer meet the conditions for hedge accounting. IAS 39 would require discontinuation of hedge accounting prospectively starting at the date the conditions were no longer met—a requirement that SMEs often say they find burdensome.

As an alternative to simplified effectiveness testing, the Board considered an approach that is in the US standard SFAS 133 Accounting for Derivative Instruments and Hedging Activities (Sections 815‑20‑25‑102 to 815‑20‑25‑117 of the FASB Codification) and is called the ‘shortcut method’. Under such a method, the IFRS for SMEs would impose strict conditions on the designation of a hedging relationship with subsequent hedge effectiveness assumed without need for measuring ineffectiveness. The Board concluded that simplified effectiveness testing is preferable to the shortcut method for two principal reasons:

Section 12 also differs from IAS 39 with respect to hedge accounting in the following ways:

The simplification in (a) is appropriate since hedge accounting would not have a significant effect on the financial statements because of the offsetting effects of the accounting for a foreign currency debt instrument under Section 11 and the recognition of exchange differences on most monetary items in profit or loss under Section 30 Foreign Currency Translation. In addition, the Board does not believe that the simplifications in (b) and (c) will affect SMEs adversely because these are not hedging strategies that are typical of SMEs.

Contracts to buy, sell, lease or insure a non-financial item such as a commodity, inventory, property, plant or equipment are accounted for as financial instruments within the scope of Section 12 if they could result in a loss to the buyer, seller, lessor, lessee or insured party as a result of contractual terms that are unrelated to changes in the price of the non-financial item, changes in foreign exchange rates, or a default by one of the counterparties. Such contracts are accounted for as financial instruments because their terms include a financial risk component that alters the settlement amount of the contract that is unrelated to the purchase or sale of, or leasing or insuring, the non-financial item.

The IFRS for SMEs gives SMEs a choice of following Sections 11 and 12 or IAS 39 in accounting for all of their financial instruments. The Board’s reasons for proposing that choice in this case are as follows:

The exposure draft had proposed that an entity electing to follow IAS 39 instead of the financial instruments sections of the IFRS for SMEs would also have to comply in full with the disclosure requirements of IFRS 7 Financial Instruments: Disclosures. Many respondents to the exposure draft argued that many of the IFRS 7 disclosures are designed for financial institutions (which are ineligible to use the IFRS for SMEs) or for entities whose securities are traded in public capital markets. In their view, the financial instruments disclosures in the IFRS for SMEs are appropriate for all SMEs including those that choose to look to IAS 39 for recognition and measurement. The Board found this argument persuasive, and the IFRS for SMEs does not require the IFRS 7 disclosures.

In their responses to the recognition and measurement questionnaire and at the round-table meetings, many preparers and auditors of SMEs’ financial statements said that the requirement in IAS 36 Impairment of Assets for an annual calculation of the recoverable amount of goodwill and other indefinite-lived intangible assets is onerous for SMEs because of the expertise and cost involved. They proposed, as an alternative, that SMEs should be required to calculate the recoverable amount of goodwill and other indefinite-lived intangible assets only if impairment is indicated. They proposed, further, that the IFRS for SMEs should include a list of indicators of impairment as guidance for SMEs. The Board agreed with those proposals. Respondents to the exposure draft supported the Board’s decision on an indicator approach to impairment. Consequently, the IFRS for SMEs establishes an indicator approach and includes a list of indicators based on both internal and external sources of information. In addition if goodwill cannot be allocated to individual cash-generating units (or groups of cash-generating units) on a non-arbitrary basis, then the IFRS for SMEs provides relief by letting the entity test goodwill for impairment by determining the recoverable amount of the acquired entity in its entirety if the goodwill relates to an acquired entity that has not been integrated. If the goodwill relates to an entity that has been integrated into the group, the recoverable amount of the entire group of entities is tested.

Many respondents to the recognition and measurement questionnaire and participants in the round-table discussions favoured requiring amortisation of goodwill and other indefinite-lived intangible assets over a specified maximum period. Proposals generally ranged from 10 to 20 years. They argued that amortisation is simpler than an impairment approach, even an impairment approach that is triggered by indicators. In developing the exposure draft, the Board did not agree with that proposal for three main reasons:

Consequently, the exposure draft proposed an impairment-only approach to goodwill and other indefinite-lived intangible assets, combined with an indicator trigger for detailed impairment calculations.

Many respondents to the exposure draft disagreed with the proposal not to require amortisation of goodwill. In fact, the single accounting recognition and measurement proposal in the exposure draft that was most frequently recommended for reconsideration was non-amortisation of goodwill. The great majority of the respondents addressing this issue recommended that amortisation of goodwill should either be permitted or be required over a limited number of years. Many of those respondents acknowledged the need for impairment testing in addition to, but not as a substitute for, amortisation. Moreover, respondents who held this view also felt that SMEs should not be required to distinguish between intangible assets with finite and indefinite useful lives. At their meeting in April 2008, working group members unanimously supported requiring amortisation of all intangibles, including goodwill, subject to an impairment test.

Some respondents holding this view acknowledged that amortisation of goodwill and other indefinite-lived intangible assets may not be the most conceptually correct approach. However, from a practical standpoint, they pointed out that many smaller entities will find it difficult to assess impairment as accurately or as promptly as larger or listed entities, meaning the information could be less reliable. Amortisation, particularly if coupled with a relatively short maximum amortisation period, would reduce the circumstances in which an impairment calculation would be triggered. They also pointed out that in the context of SMEs, users of financial statements say they find little, if any, information content in goodwill at all; for example, lenders generally do not lend against goodwill as an asset.

After considering the various views expressed, the Board concluded―for cost-benefit reasons, rather than conceptual reasons―that goodwill and other indefinite-lived intangible assets should be considered to have finite lives. Therefore, such assets should be amortised over their estimated useful lives, with a maximum amortisation period of ten years. The assets must also be assessed for impairment using the ‘indicator approach’ in the IFRS for SMEs.

IAS 38 requires all research costs to be charged to expense when incurred, but development costs incurred after the project is deemed to be commercially viable are to be capitalised. Many preparers and auditors of SMEs’ financial statements said that SMEs do not have the resources to assess whether a project is commercially viable on an ongoing basis and, furthermore, capitalisation of only a portion of the development costs does not provide useful information. Bank lending officers told the Board that information about capitalised development costs is of little benefit to them, and that they disregard those costs in making lending decisions.

The Board accepted those views, and the IFRS for SMEs requires all research and development costs to be recognised as expenses when incurred.

IAS 28 requires an entity to account for its investments in associates by the equity method. IAS 31 allows an entity to account for its investments in jointly controlled entities by either the equity method or proportionate consolidation. Many preparers of SMEs’ financial statements questioned the usefulness of both of those accounting methods and told the Board that SMEs have particular difficulty in applying those methods because of inability to obtain the required information and the need to conform accounting policies and reporting dates. In their view, the cost method—which is permitted under IAS 28 and IAS 31 in accounting for investments in associates and joint ventures in the investor’s separate financial statements—should also be permitted under the IFRS for SMEs in the investor’s consolidated financial statements. Lenders generally indicated that information reported using the equity method and proportionate consolidation is of limited use to them because it is not useful in assessing either future cash flows or loan security. Fair values are more relevant for those purposes. Recognising the special problems of SMEs in applying the equity and proportionate consolidation methods, and also the relevance of fair values for lenders, the Board concluded that SMEs should be permitted to use either the cost method or fair value through profit or loss.

IAS 28 requires investments in associates to be measured using the equity method. IAS 31 requires investments in jointly controlled entities to be measured using either the equity method or proportionate consolidation. Neither of those standards makes an accounting measurement distinction if such investments happen to have a published price quotation.

The IFRS for SMEs requires that any investment in an associate or jointly controlled entity for which there is a published price quotation must be measured at fair value through profit or loss. The Board’s reasons for reaching this decision were (a) concerns about measurement reliability are substantially eliminated, (b) the cost of obtaining a fair valuation is substantially eliminated and (c) such fair values are more relevant than cost-based measurements to lenders and other users of SMEs’ financial statements.

IFRS 5 defines when non-current assets or groups of assets (and associated liabilities) are ‘held for sale’ and establishes accounting requirements for such assets. The accounting requirements are, in essence, (a) stop depreciating the asset (or assets in the group) and (b) measure the asset (or group) at the lower of carrying amount and fair value less costs to sell. There is also a requirement to disclose information about all non-current assets (groups) held for sale. The exposure draft of the IFRS for SMEs had proposed nearly identical requirements.

Many respondents to the exposure draft recommended that the IFRS for SMEs should not have a separate held-for-sale classification for cost-benefit reasons, and working group members concurred. They felt that an accounting result similar to that of IFRS 5 could be achieved more simply by including intention to sell as an indicator of impairment. Many who held this view also recommended that the IFRS for SMEs require disclosure when an entity has a binding sale agreement for a major disposal of assets, or a group of assets or liabilities. The Board agreed with those recommendations because (a) the impairment requirements in the IFRS would ensure that assets are not overstated in the financial statements and (b) the disclosure requirements will provide relevant information to users of SMEs’ financial statements.

IAS 23 requires borrowing costs directly attributable to the acquisition, construction or production of a qualifying asset to be capitalised as part of the cost of the asset. For cost-benefit reasons, the IFRS for SMEs requires such costs to be charged to expense.

In their responses to the questionnaire and at the round-table meetings, many preparers and auditors of SMEs’ financial statements said that the temporary difference approach to accounting for income taxes in IAS 12 Income Taxes is difficult for SMEs to implement. They said that SMEs do not routinely prepare ‘tax balance sheets’ and generally do not track the tax bases of many assets. Some advocated a ‘current taxes payable’ method of accounting for income taxes, under which SMEs would not recognise deferred taxes.

The Board did not support the ‘current taxes payable’ approach for the reasons explained in paragraph BC145. However, while believing that the principle of recognising deferred tax assets and liabilities is appropriate for SMEs, the Board also concluded that implementation of that principle could be simplified for SMEs. Section  29 Income Tax of the IFRS for SMEs uses the approach set out in the Board’s exposure draft Income Tax, published in March 2009, which proposes a simplified replacement for IAS 12. The only significant measurement difference in the IFRS for SMEs as compared with the exposure draft Income Tax is where a different tax rate applies to distributed and undistributed income. The IFRS for SMEs requires current and deferred taxes to be measured initially at the rate applicable to undistributed profits, with adjustment in subsequent periods if the profits are distributed. The Income Tax exposure draft would initially measure current and deferred taxes at the tax rate expected to apply when the profits are distributed.

IAS 21 requires exchange differences arising on a monetary item that forms part of a reporting entity’s net investment in a foreign operation to be recognised in profit or loss in the separate financial statements of the reporting entity or the individual financial statements of the foreign operation. In the financial statements that include the foreign operation and the reporting entity (eg consolidated financial statements when the foreign operation is a subsidiary), IAS 21 recognises such exchange differences initially in other comprehensive income and reclassifies them from equity to profit or loss on disposal of the net investment. The IFRS for SMEs provides for one difference: an exchange difference that is recognised initially in other comprehensive income is not reclassified in profit or loss on disposal of the investment. The reason for the difference is that not requiring reclassification is less burdensome for SMEs because it eliminates the need for tracking the exchange differences after initial recognition.

IAS 19 requires that a defined benefit obligation should always be measured using the projected unit credit actuarial method. For cost-benefit reasons, the IFRS for SMEs provides for some measurement simplifications that retain the basic IAS 19 principles but reduce the need for SMEs to engage external specialists. Therefore, the Board decided:

One of the principal complexities of IAS 19 is recognition of actuarial gains and losses. Under IAS 19, an entity can choose any of the following options:

The IFRS for SMEs does not permit either of the deferral and amortisation methods described in (c) or (d). Instead, it requires immediate recognition with an option to present the amount either in profit or loss (method (a)) or in other comprehensive income (method (b)). Methods (a) and (b) are far simpler than either of the deferral and amortisation methods. Methods (c) and (d) require tracking of data over many years and annual calculations. Moreover, financial statement users generally have told the Board that they find immediate recognition (methods (a) and (b)) provides the most understandable and useful information.

Past service cost relating to employee service in prior periods arises when a new defined benefit plan is introduced or an existing plan is changed. IAS 19 requires past service cost to be deferred and amortised as an expense (or, in the case of benefit reductions, as income) on a straight-line basis over the average period until the benefits become vested. To the extent that the benefits vest immediately when a plan is introduced or changed, the past service cost is recognised in profit or loss immediately. The IFRS for SMEs requires immediate recognition of all past service cost (including that related to unvested benefits), without any deferral. The Board believes that the method in the IFRS for SMEs is simpler because it does not require tracking of data over many years or annual calculations. A deferred recognition model relegates important information about the funding status of post-retirement plans to the notes to the financial statements. Further, deferred recognition treats changes to an entity’s pension assets and liabilities differently from changes to the entity’s other assets and liabilities.

The exposure draft had proposed that SMEs should apply IFRS 2 in measuring equity-settled share-based payment transactions, and that the entity should make the disclosures required by IFRS 2. The Board’s reasoning was that IFRS 2 already provided a simplification for SMEs because, if an entity is unable to estimate reliably the fair value of the equity instruments granted at the measurement date, the entity is permitted to measure the equity instruments at intrinsic value. Most respondents to the exposure draft said that the intrinsic value method is not much of a simplification as this method requires knowing the fair value of the underlying shares when the share option (or other share-based payment) is granted and at each subsequent reporting date. The working group shared this concern about IFRS 2.

The Board considered the views of these respondents and the working group and concluded that further simplifications are appropriate for cost-benefit reasons. As a matter of principle, the Board concluded that SMEs should always recognise an expense for equity-settled share-based payments and that the expense should be measured on the basis of observable market prices, if available. If observable market prices are not available, SMEs should measure the expense using the directors’ best estimate of the fair value of the equity-settled share-based payment. The Board also decided that disclosure only, without expense recognition, is not appropriate.

The Board also decided that for SMEs’ share-based payment transactions that give either the entity or the counterparty a choice of settlement in cash or equity instruments, the entity should account for the transaction as a cash-settled share-based payment transaction unless either

In circumstances (a) and (b), the transaction is accounted for as equity-settled.

IFRS 1 requires an entity’s first IFRS financial statements to include at least one year of comparative information under IFRSs. Some preparers and auditors of SMEs’ financial statements explained to the Board that a requirement to prepare restated prior period data in all cases would be burdensome for SMEs adopting the IFRS for SMEs for the first time. Thus, the IFRS for SMEs includes an ‘impracticability’ exemption. Similarly, it provides an impracticability exemption with respect to some requirements for restating the opening statement of financial position.

IAS 40 allows an accounting policy choice of either fair value through profit or loss or a cost-depreciation-impairment model (with some limited exceptions). An entity following the cost-depreciation-impairment model is required to provide supplemental disclosure of the fair value of its investment property. The IFRS for SMEs does not have an accounting policy choice but, rather, the accounting for investment property is driven by circumstances. If an entity knows or can measure the fair value of an item of investment property without undue cost or effort, it must use the fair value through profit or loss model for that investment property. It must use the cost-depreciation-impairment model for other investment property. Unlike IAS 40, the IFRS for SMEs does not require disclosure of the fair values of investment property measured on a cost basis.

The IFRS for SMEs requires a single, simplified method of accounting for all government grants. All grants are recognised in income when the performance conditions are met or earlier if there are no performance conditions. All grants are measured at the fair value of the asset received or receivable. IAS 20 permits a range of other methods that are not allowed by the IFRS for SMEs.

The IFRS for SMEs does not require a lessee to recognise lease payments under operating leases on a straight-line basis if the payments to the lessor are structured to increase in line with expected general inflation (based on published indexes or statistics) to compensate for the lessor’s expected inflationary cost increases. That exception to the straight-line basis is not in IAS 17 Leases.

The IFRS for SMEs does not require an annual review of the useful life, residual value, and depreciation or amortisation method for property, plant and equipment and intangible assets. Instead, a review is required only if there is an indication that there has been a significant change since the last annual reporting date. IAS 16 and IAS 38 require reviews at least at each financial year-end.

Some suggested that the Board should not require SMEs to prepare a cash flow statement. Some who held this view believed that preparing a cash flow statement is burdensome. Some contended that users of SMEs’ financial statements do not find the cash flow statement useful.

The Board noted that if a comparative statement of financial position (with amounts for the beginning and the end of the reporting period) and an income statement are available, preparing a cash flow statement is not a difficult, time-consuming or costly task. The accounting frameworks of most jurisdictions require broad groups of entities, including SMEs, to prepare a cash flow statement. Moreover, the great majority of users of SMEs’ financial statements who have communicated with the Board—including particularly lenders and short-term creditors—indicated that the cash flow statement is very useful to them.

IAS 17 does not recognise a lessee’s rights and obligations under a lease in the statement of financial position if the lease is classified as an operating lease. Although lessees obtain rights and incur obligations under all leases, finance leases create obligations substantially equivalent to those arising when an asset is purchased on credit. Information about such assets and obligations is important for lending and other credit decisions. Treating all leases as operating leases would remove useful information from the statement of financial position.

As with leases, users of financial statements are concerned about ‘off balance sheet obligations’. Many jurisdictions require SMEs by law to provide benefits that are the equivalent of a defined benefit pension plan—for example, long-service benefits. Users of SMEs’ financial statements consistently say that information about the funding status of such obligations is useful and important to them.

The completed contract method can produce a potentially misleading accounting result for a construction contractor, with initial years of no profit at all followed by full recognition of profit when the construction is completed. Many construction contractors are SMEs. The fluctuation between years of large profit and years of large losses may be magnified for SMEs because they tend to have fewer contracts than larger entities. Users of financial statements have told the Board that, for a contractor, the percentage of completion method provides information that they find more useful than the completed contract method.

Provisions are liabilities of uncertain timing or amount. Despite the uncertainties, they are obligations that have met the liability recognition criteria. Users of SMEs’ financial statements consistently say they want these obligations recognised in the statement of financial position, with the measurement uncertainties explained.

Non-recognition is inconsistent with the definitions of the elements of financial statements, especially an expense. Moreover, users of financial statements generally hold the view that share-based payments to employees should be recognised as remuneration expense because (a) they are intended as remuneration, (b) they involve giving something of value in exchange for services and (c) the consumption of the employee services received is an expense. Although Section 26 requires recognition of the expense, it also provides for simplified measurement as compared with IFRS 2.

Some support the ‘taxes payable method’ of accounting for income taxes. Under that method, only income taxes currently payable or refundable are recognised; deferred taxes are not recognised. Many users of SMEs’ financial statements disagree with the taxes payable method. They point out that deferred taxes are liabilities (or sometimes assets) that can result in large outflows (inflows) of cash in the near future and, therefore, should be recognised. Even those users of financial statements who do not agree that deferred tax liabilities or deferred tax assets should be recognised generally want the amounts, causes and other information disclosed in the notes. Note disclosure would entail the same tracking and computation effort for SMEs as would recognition, but would be inconsistent with the principles for recognising assets and liabilities in the Framework. The Board concluded that making a fundamental departure from the recognition principles in IAS 12 while requiring disclosure of the information that users of SMEs’ financial statements find useful is not justified on a cost-benefit basis. Moreover, the Board believes that deferred taxes satisfy the requirements for recognition as assets and liabilities and can be measured reliably.

Not only is fair value generally regarded as a more relevant measure in this industry, quoted prices are often readily available, markets are active, and measuring cost is actually more burdensome and arbitrary because of the extensive allocations required. Moreover, managers of most SMEs that undertake agricultural activities say that they manage on the basis of market prices or other measures of current value rather than historical costs. Users also question the meaningfulness of allocated costs in this industry.

In many countries, SMEs are organised into two or more legal entities for tax or other legal reasons, even though they operate as one economic entity. Investors, lenders and other users of SMEs’ financial statements say that they find information about the financial position, operating results and cash flows of the economic entity useful for their decisions. They say they cannot use the separate financial statements of the legal entities because those entities often enter into transactions with each other that are not necessarily structured or priced on an arm’s length basis. In such circumstances, the amounts reported in the separate statements reflect internal transactions (eg sales between the legal entities) that are not transactions of the economic entity with other economic entities. Also, the entities are often jointly managed, and loans are cross-collateralised. In the Board’s judgement, consolidated statements are essential for users when two entities operate as a single economic entity.

The IFRS for SMEs requires SMEs to recognise items of income or expense in other comprehensive income, rather than in profit or loss, in three circumstances:

In developing the IFRS for SMEs, the Board considered whether to require SMEs to recognise the foreign exchange gains or losses and actuarial gains and losses only in profit or loss, rather than as part of other comprehensive income. Because the IFRS for SMEs requires SMEs to present a statement of comprehensive income, the Board concluded not to require presentation of those gains and losses in profit or loss.

Because the Board has begun a comprehensive project on financial instruments as part of its convergence programme with the US Financial Accounting Standards Board, the Board did not consider requiring SMEs to recognise changes in the fair value of all hedging instruments in profit or loss at this time.