This article explains the approach taken by the IASB and reflects on the alignment approach adopted by the board. This article will be followed with two more articles in the same series on the third edition of the IFRS for SMEs Accounting Standard. In the follow-up articles where we also question whether, should the board continue with its approach of alignment, IFRS for SME’s would lose its relevance, and whether South Africa should look towards adopting a reporting framework for micro entities.
The International Accounting Standards board (IASB or board) has recently released the third edition of its IFRS for SMEs Accounting Standard (SME Accounting Standard). This edition represents a major update to the Standard and follows a comprehensive review conducted by the IASB over the past few years. The updates to the SME Accounting Standard cover all sections of the current IFRS for SMEs. Some of the most significant updates are on the topics of revenue recognition, fair value measurement and business combinations. Revenue recognition and business combinations were updated to align more closely with the detailed requirements of IFRS Accounting Standards.
Section 12 “Fair Value measurement” has been added to the SME Accounting Standard for the first time in this edition. Previously, information about fair value measurement and disclosure was spread throughout the other sections where it was relevant, but in the third edition this is now grouped into a new separate section. Many respondents, network firms and practitioners have indicated their support for this new edition of the Standard, expecting the overall improvement of the quality of financial information being reported by SMEs.
Alignment approach
The SME Accounting Standard was originally developed using an alignment approach. That is, the Standard was based on the 1989 Framework for the Preparation and Presentation of Financial Statements and the principles and related requirements of full IFRS Standards, with modifications that were appropriate in the light of users’ needs and cost-benefit considerations. In considering how to approach this comprehensive review of the SME Accounting Standard, the board considered whether it should continue to follow the alignment approach or if the board should only consider issues raised by stakeholders regarding the IFRS for SMEs Standard, without necessarily considering the direction taken by full IFRS Standards.
The second approach would see the SME Accounting Standard diverge from full IFRS Standards over time and become an independent Standard. The board’s adopted approach to the review was to continue to align the principles in the SME Accounting Standard with those in full IFRS Accounting Standards.
In line with the board’s proposed approach, each possible amendment to the SME Accounting Standard starts as complete alignment of the recognition and measurement requirements with those in IFRS Accounting Standards, albeit expressed in a simplified way. The board’s starting point is with the intention of incorporating the substance of a new or amended IFRS Accounting Standard into the IFRS for SMEs Accounting Standard and adapt that new or amended IFRS Standard by applying the three alignment principles in turn.
The first of the alignment principles is relevance. This is where the board considers whether a change to IFRS Accounting Standards is relevant to the financial statements of a typical SME and whether any additional information provided in an entity’s financial statements in accordance with those amendments is useful. A good example of the application of the relevance principle is the board’s discussion on excluding the expected credit loss model set out in IFRS 9 Financial Instruments. The board concluded that because of the scope limitation in the SME Accounting Standard, it is unlikely that including this requirement for SMEs would provide useful information.
The second alignment principle is simplicity, which requires the board to consider whether a principle in full IFRS Accounting Standards can be applied in a simpler way. An example where the board applied this principle is in the assessment of whether one company controls another. IFRS 10 Consolidated Financial Statements sets out a detailed process for making this assessment. The board considered that while it would be useful for the SME Accounting Standard to retain elements of this test, companies would find it much simpler to make the assessment if the board retained a rebuttable presumption that control exists where an entity holds more than 50% of the voting rights.
The simplicity principle also assisted the board with considering requirements such as the application of the undue cost or effort exemption and with reducing the number of categories for classifying financial assets.
The final principle relates to faithful representation. The board considers whether, applying a simplified approach, the outcome would faithfully represent in words and numbers the activities of an SME in its financial statements. The third principle is arguably a safety net to ensure that the simplification applied in formulating the amendment is appropriate and does not, perhaps in concert with other simplifications, significantly reduce the usefulness of the financial statements.
The board continuously emphasised that the aim of the board and its adopted alignment approach is to simplify and adapt a requirement originating from full IFRS Accounting Standards so it meets the needs of the users of SME financial statements. In this way, the SME Accounting Standard keeps its unique characteristics and remains suited to the companies in its scope, while retaining its link to full IFRS Standards. This approach provides the board with a framework to move within a range, while requiring the board to consider rigorously and justify any differences between full IFRS Accounting Standards and the SME Accounting Standard.
The alternatives
In our observations, and those who attended Saica’s IFRS for SME panel discussions would recall, that there are differing views on whether the alignment approach is the best way forward.
Those in support of the alignment approach considers amongst other factors, the wide application of both the full IFRS Accounting Standards and the SME Accounting Standards, the ability of the board to leverage implementation experience from the respective full IFRS Accounting Standards and avoiding continual divergence between the two sets of Standards.
Support to reduce divergence between the two sets of Standards is believed to enable SMEs to achieve accounting consistency with its large-sized counterparts while retaining sufficient flexibility, and arguably the greatest motivation is to be more conducive for those SMEs anticipated to access capital markets at a later stage at which point it would be required to migrate to full IFRS Accounting Standards, evidently lowering transition costs.
Those arguing against a full alignment approach seems to be more focused on the user of an SME’s financial statements, in particular, pointing to simpler financing structures and limited trading in shares. Should there be full alignment, SMEs may find the IFRS for SMEs Accounting Standard complicated and not cost efficient to apply. This view seems to support an 'independent Standard approach' being more suitable, as it would allow greater flexibility to effectively address SME’s needs and challenges.
The key to determining the most appropriate approach rests with understanding the original objective of developing the SME Accounting Standard and assessing whether the current direction is line with that objective. In particular, it is important to understand whether the objective then was to develop a simplified Standard fit for the purpose of SME reporting, or whether it was intended as a stepping stone towards the adoption of the full IFRS Standards, the latter may however involve a smaller proportion of the SMEs.
A greater degree of alignment with the full IFRS Standards may have the unintended consequence of compromising simplification efforts. This is already evident as SMEs will have to navigate the complexities of the revised Revenue section. Auditors, preparers and regulators would recall the significant amount of work required when companies reporting under full IFRS implemented IFRS 15.
The shift of the SME Accounting Standard away from being a simplified Standard fit for the purpose of SME reporting may inadvertently discourage certain jurisdictions from its adoption or continued adoption. Ultimately, having a clear understanding of who the users of SME financial statements are, as well as the original objective, subsequent changes to it, and the reasons for such changes, is crucial to the standard-setting process in order to ensure that the final Standard continues to be fit for purpose.
