1. 1 © 2005 IASC Foundation, all rights reserved. Accounting Standards for Small and Medium-sized Entities Paul Pacter, IASB Director of Standards for SMEs National Accountants Conference Malaysian Institute of Accountants 23 November 2005

2. 2 © 2005 IASC Foundation, all rights reserved. IASB’s Preliminary Views  IASB deliberated SME GAAP during second half of 2003 and early 2004:  Reached some preliminary views on approach.  Discussion Paper - June 2004.  Comments - due Sept 2004.  Responses to selected issues follow:

3. 3 © 2005 IASC Foundation, all rights reserved. IASB’s Preliminary Views  PV 1.1: Full IFRSs are suitable for all entities  Full IFRSs means IASs, IFRSs, SIC Interpretations, & IFRIC Interpretations. Responses to DP:  2/3 disagreed, arguing that IFRSs are mainly designed for listed companies.

4. 4 © 2005 IASC Foundation, all rights reserved. IASB’s Preliminary Views  PV 1.2: IASB will develop a set of financial reporting standards suitable only for those entities that do not have public accountability. Responses to DP:  Overwhelmingly (90%) agreed that IASB should develop SME standards. Other 10% would not have separate set but rather “SME minuses” in full IFRSs.

5. 5 © 2005 IASC Foundation, all rights reserved. IASB’s Preliminary Views PV 2: Objective of IASB standards for SMEs: a.High quality, understandable, and enforceable standards suitable for SMEs globally. b.Meet user needs. c.Same conceptual framework. d.Reduce preparer burden. e.Easy transition to full IFRSs.

6. 6 © 2005 IASC Foundation, all rights reserved. IASB’s Preliminary Views  PV 2: Responses to DP:  50% agreed in full.  40% concerned about implications of same conceptual framework (c).  Many said transition to full IFRSs (e) is unimportant (uncommon).

7. 7 © 2005 IASC Foundation, all rights reserved. IASB’s Preliminary Views  PV 3.1: IASB will describe the characteristics of entities for which the SME standards are intended.  But no quantified size test.  National jurisdictions determine which entities that meet IASB’s characteristics should be required or permitted to use IASB Standards for SMEs.

8. 8 © 2005 IASC Foundation, all rights reserved. IASB’s Preliminary Views  PV 3.2: In principle, an entity has public accountability if:  High degree of outside interest from non-management investors who depend on external financial reporting.  Essential public service responsibility because of the nature of its operations.

9. 9 © 2005 IASC Foundation, all rights reserved. IASB’s Preliminary Views  PV 3.3: Presumptive indicators that an entity has public accountability: 1.Has filed financial statements with securities regulator (or in process) 2.Holds assets in fiduciary capacity:  Bank, insurance, securities, pension fund, mutual fund, etc. 3.Public utility:  Electric, gas, water, phone, etc. 4.Economically significant in its home country.

10. 10 © 2005 IASC Foundation, all rights reserved. IASB’s Preliminary Views Responses to DP:  80% supported a “characteristics approach” ̶ no quantified size.  Most found “public accountability” a sensible dividing point.  Many other comments.

11. 11 © 2005 IASC Foundation, all rights reserved. IASB’s Preliminary Views  PV 3.4: All owners must agree to using SME standards. Responses to DP:  82% disagreed – “inappropriate and impractical”. One dissident shareholder could thwart the will of great majority.

12. 12 © 2005 IASC Foundation, all rights reserved. IASB’s Preliminary Views  PV 3.5: The IASB intends to include all entities that do not have public accountability as potential adopters of IASB Standards for SMEs.  Not focused only on the large ones or only on the small ones. Responses to DP:  70% felt “one size can fit all” SMEs.

13. 13 © 2005 IASC Foundation, all rights reserved. IASB’s Preliminary Views  PV 3.6: If a subsidiary, joint venture, or associate of an entity with public accountability prepares IFRS financial information to meet the requirements of its parent or investor, it should comply with full IFRSs in its separate statements.  No extra cost or burden.

14. 14 © 2005 IASC Foundation, all rights reserved. IASB’s Preliminary Views  PV 3.6: Responses to DP:  70% disagreed. Circumstances of the sub, not its parent, should determine which standards the sub follows.  Also different materiality.

15. 15 © 2005 IASC Foundation, all rights reserved. IASB’s Preliminary Views  PV 4: Mandatory fallback to IFRS if SME Standards do not address a particular accounting recognition or measurement issue that is addressed in an IFRS.  Company would continue to use Standards for SMEs for the remainder of its reporting.

16. 16 © 2005 IASC Foundation, all rights reserved. IASB’s Preliminary Views  PV 4: Responses to DP:  67% agreed with “mandatory fallback” to full IFRSs.  The other 33% felt it imposes full IFRSs on SMEs instead of SME standards.

17. 17 © 2005 IASC Foundation, all rights reserved. IASB’s Preliminary Views  PV 5: If an IASB Standard for SMEs provides an exemption or simplification from a recognition or measurement requirement in the related IFRS, an entity that uses IASB Standards for SMEs could choose to apply the IFRS while otherwise continuing to use IASB Standards for SMEs.  Must follow the entire related IFRS, not just parts of it.

18. 18 © 2005 IASC Foundation, all rights reserved. IASB’s Preliminary Views  PV 5: Responses to DP:  60% opposed the “optional fallback” to full IFRSs. Concerned about pick-and-mix, cherry picking, and large number of permutations of SME GAAP.

19. 19 © 2005 IASC Foundation, all rights reserved. IASB’s Preliminary Views  PV 6: Development of IASB Standards for SMEs should start by extracting the concepts and principles from IFRSs (including interpretations). Responses to DP:  80% agreed. Other 20% felt IASB should approach SME standards with a clean slate ̶ based on SME user needs.

20. 20 © 2005 IASC Foundation, all rights reserved. IASB’s Preliminary Views  PV 7.1: Any modifications to the concepts or principles in IFRSs must be based on the identified needs of users of SME financial statements or cost-benefit analyses. Responses to DP:  90% agreed.

21. 21 © 2005 IASC Foundation, all rights reserved. IASB’s Preliminary Views  PV 7.2: It is likely that disclosure and presentation modifications will be justified based on user needs and cost benefit analyses.  Some disclosures may be added, not just deleted. Responses to DP:  98% supported disclosure and presentation modifications.

22. 22 © 2005 IASC Foundation, all rights reserved. IASB’s Preliminary Views  PV 7.3: There would be a rebuttable presumption that no modifications would be made to the recognition and measurement principles in IFRSs.  Such modifications could be justified only on the basis of user needs or a cost benefit analysis.  Recognition modifications are less likely than measurement ones, because they would mean different definitions of assets and liabilities.

23. 23 © 2005 IASC Foundation, all rights reserved. IASB’s Preliminary Views  PV 7.3: Responses to DP:  65% did not agree. Felt recognition and measurement modifications are needed. Concerned that IASB is prejudging. Cited growing measurement complexities in IFRSs.

24. 24 © 2005 IASC Foundation, all rights reserved. January 2005 Decisions  Board discussed responses 4Q 2004 and in Jan. 2005 - made tentative decisions: 1.Clear demand for IASB SME standards. 2.Focus on non-publicly accountable entities that publish general purpose financial statements for external users.

25. 25 © 2005 IASC Foundation, all rights reserved. January 2005 Decisions 3.Each jurisdiction should develop detailed guidelines on which entities are eligible to use. 4.Board will consider recognition and measurement simplifications – based on user needs and cost/benefit. 5.“Mandatory fallback” – Yes. 6.“Optional fallback” – No.

26. 26 © 2005 IASC Foundation, all rights reserved. January 2005 Decisions 7.Clear disclosure that full IFRSs are not being followed. 8.Organise topically, with cross- references to IASs/IFRSs. 9.Add preparers and users to Advisory Group. [Done] 10. Conduct round tables with preparers and users. [Done]

27. 27 © 2005 IASC Foundation, all rights reserved. Mandatory Fallback  Different meanings:  SME standards omit an issue because it is expected to have limited applicability to SMEs and the Board concludes that SME should look to full IFRS.  SME standards only include the simpler of two policy choices allowed in IFRSs, but the Board concludes that the other choice should also be available to SMEs.  SME standards simply do not address an issue. Then?  Fallback to IFRSs required?  Look to hierarchy in SME version of IAS 8?

28. 28 © 2005 IASC Foundation, all rights reserved. Working Definition of SME  SME: IASB usage  Does not have public accountability:  Not publicly traded.  Not financial institution.  Not essential public service.  Not economically significant in its home country.  Publishes general purpose financial statements for external users.

29. 29 © 2005 IASC Foundation, all rights reserved. Recognition and Measurement Questionnaire  1 April 2005:  Brief questionnaire was sent to all DP respondents, SAC, Working Group, and posted for public response.  To identify recognition and measurement issues for discussion at round tables.  101 responses received.

30. 30 © 2005 IASC Foundation, all rights reserved. Recognition and Measurement Questionnaire  28 June 2005:  Discussed responses with SAC and received views.  29-30 June 2005:  IASB SME Working Group met.  Discussed responses.  Prepared recommendations for the Board.

31. 31 © 2005 IASC Foundation, all rights reserved. Recognition and Measurement Questionnaire  26 September  Discussion with World Standard Setters from over 40 countries.  13-14 October 2005:  Round-table discussions of possible recognition and measurement simplifications.  45 groups participated.

32. 32 © 2005 IASC Foundation, all rights reserved. Questionnaire  Questionnaire identified areas for possible recognition and measurement simplification: Income taxes Pensions/OPEBs Goodwill impairment Derecognition PP&E impairment Hedge accounting Inventory cost FV under IAS 39 Effective interest Share-based payment % completion Intangibles costs Provisions Equity method LeasesConsolidation

33. 33 © 2005 IASC Foundation, all rights reserved. Questionnaire  Questionnaire asked respondents:  What is the specific problem for SME?  Why is it a problem?  How to fix while keeping to the principle in the IFRS (if appropriate)? Example: Share-based payment  Problem: “Measuring FV of a share option for unlisted company”. This is not specific enough!  Problem: “Determining volatility factor for unlisted company”.

34. 34 © 2005 IASC Foundation, all rights reserved. Some Working Group Views  IFRSs should consist of:  Full IFRSs – designed for entities with public accountability.  IFRSs for SMEs – designed for entities without public accountability.  National jurisdictions decide who uses.  Full IFRSs should have some disclosure exemptions for unlisted entities with public accountability.

35. 35 © 2005 IASC Foundation, all rights reserved. Some Working Group Views  In developing IFRSs for SMEs, IASB should have in mind non-publicly accountable entities with about:  50 employees, and  Annual revenue of €10M.  IASB aim toward SME standards totalling 200 A5 pages in length.

36. 36 © 2005 IASC Foundation, all rights reserved. Some Working Group Views  No general mandatory fallback.  But yes to specific fallbacks where items of limited SME applicability are intentionally omitted.  Generally, where IFRS allows an accounting policy choices, SME standard should include only the simpler choice.  Where appropriate allow SME to use the more complex choice in full IFRS.

37. 37 © 2005 IASC Foundation, all rights reserved. Some Working Group Views  Working group is concerned about 2 conditions in IASB SME definition:  If entity provides “essential public service” must use full IFRSs regardless of size.  Economic significance in home country.  WG view is let each jurisdiction decide.

38. 38 © 2005 IASC Foundation, all rights reserved. Possible Simplifications  Next slides present “General views” which are:  Combination of questionnaire responses and Working Group (WG).  Ideas for the Board to consider.  “No major simplification needed” still means should be substantial reduction in text from full IFRS.

39. 39 © 2005 IASC Foundation, all rights reserved. Possible Simplifications  IAS 2 Measuring the cost of inventories  General view: No major simplification needed.  Some responses wanted measurement simplifications.  Various ones proposed (eg measure at selling price less normal profit).

40. 40 © 2005 IASC Foundation, all rights reserved. Possible Simplifications  IAS 7 – Cash flow statement  General view: Continue to require SME to include cash flow statement.  No major change needed.  Some responses would:  Make it optional.  Simplify the format.  Conduct a study of user needs.

41. 41 © 2005 IASC Foundation, all rights reserved. Possible Simplifications  IAS 8 – Accounting policy changes  General view: No major simplification needed.  Some responses: For SME, all changes prospective.

42. 42 © 2005 IASC Foundation, all rights reserved. Possible Simplifications  IAS 10 – Events after balance sheet date  General view: No major simplification needed.  Some respondents: For SME, all are non-adjusting (disclosure only, no recognition).

43. 43 © 2005 IASC Foundation, all rights reserved. Possible Simplifications  IAS 11 Construction contracts  General view: No major simplification needed.  Some responses wanted measurement simplifications (generally completed contract with loss recognition).

44. 44 © 2005 IASC Foundation, all rights reserved. Possible Simplifications  IAS 12 Deferred income taxes  General views:  Major simplification needed  Board should consider flow- through for SMEs (no deferred taxes).  If deferred taxes retained, many measurement simplifications were suggested.

45. 45 © 2005 IASC Foundation, all rights reserved. Possible Simplifications  IAS 16 – Depreciation  General view: No major simplification needed.  Some respondents:  Use rates allowed for income tax purposes.  No component approach – depreciate individual items only.

46. 46 © 2005 IASC Foundation, all rights reserved. Possible Simplifications  IAS 16 – Depreciation – requirement to review useful life, depreciation rate, residual value annually:  General view: No major simplification needed.

47. 47 © 2005 IASC Foundation, all rights reserved. Possible Simplifications  IAS 16 – Revaluation model  General view: Prohibit reval model for SMEs.  Some WG and respondents would retain the reval model via optional fallback to IAS 16.

48. 48 © 2005 IASC Foundation, all rights reserved. Possible Simplifications  IAS 17 Leases  General views:  Major simplification needed.  All operating (with extra disclosure).  Some favour capitalise all.  Some favour retaining both operating and capital leases but simplified measurements.

49. 49 © 2005 IASC Foundation, all rights reserved. Possible Simplifications  IAS 18 Recognition of service revenue  General view: No major simplification needed.  A few responses wanted measurement simplifications  Especially for service revenue

50. 50 © 2005 IASC Foundation, all rights reserved. Possible Simplifications  IAS 19 Pensions etc.  General views:  Major simplification needed.  Treat all pensions as defined contribution, with disclosures.  WG view: Retain all IAS 19 options re actuarial gains and losses, including corridor, until IASB revises IAS 19.

51. 51 © 2005 IASC Foundation, all rights reserved. Possible Simplifications  IAS 23 – Capitalisation of borrowing costs  General view: SME standard should provide only for expensing, but allow optional fallback to IAS 23 if SME wants to capitalise.

52. 52 © 2005 IASC Foundation, all rights reserved. Possible Simplifications  IAS 27 Subsidiaries  General view (including most WG members):  Measure investment in sub at cost with impairment (no consolidation).  Other views:  Limit consolidation to only if: (i) cross collateralisation, (ii) sub is not operated stand-alone, or (iii) central treasury.  Measure investment in sub as IAS 39 AFS (FV change to equity) with impairment.  Option to consolidate.

53. 53 © 2005 IASC Foundation, all rights reserved. Possible Simplifications  IAS 28 Associates and IAS 31 Joint Ventures  General view: Simplification needed.  Measure at cost less impairment.

54. 54 © 2005 IASC Foundation, all rights reserved. Possible Simplifications  IAS 36 and IFRS 3 - Goodwill  General view is do not consolidate. Carry sub at cost less impairment:  In which case goodwill goes away.  If that is not done, require amortisation of goodwill (10, 12, 20 years?) instead of annual impairment test.  If impairment approach retained, assess ‘every few years’ rather than annually or only if impairment is ‘very obvious’ (clear under-usage, damage, intent to sell).  FV rather than value in use.

55. 55 © 2005 IASC Foundation, all rights reserved. Possible Simplifications  IAS 36 – PP&E  General view: Major measurement simplifications needed, but keep principle that assets not carried at more than recoverable amount  Recognise impairment only when clear under-usage, damage, intent to sell.  Simplify calculations – FV only, not value-in-use.

56. 56 © 2005 IASC Foundation, all rights reserved. Possible Simplifications  IAS 37 - Provisions  WG did not discuss due to current IAS 37 ED.  Most responses recommended measurement simplifications:  No discounting.  Assess in the aggregate by segment.  Lower degree of measurement reliability.  Limit indicators of impairment.  Higher recognition threshold than ‘more likely than not’.

57. 57 © 2005 IASC Foundation, all rights reserved. Possible Simplifications  IAS 38 – Internally generated intangibles  General view was divided:  Some say “commercial viability” test for capitalising development costs is not burdensome.  Others say it is burdensome. Simplify by not capitalising R&D at all.

58. 58 © 2005 IASC Foundation, all rights reserved. Possible Simplifications  IAS 38 – Revaluation model for intangibles  General view: Prohibit reval model for SMEs.  Some WG and respondents would retain the reval model via optional fallback to IAS 38.

59. 59 © 2005 IASC Foundation, all rights reserved. Possible Simplifications  IAS 39 – Effective interest method  General view: Simplification needed for SMEs.  Straight-line measurement instead.  Only require effective interest method for cash flows that extend beyond two years from balance sheet date.

60. 60 © 2005 IASC Foundation, all rights reserved. Possible Simplifications  IAS 39 – Fair value measurement  General view: Major simplification needed.  Many proposals, but basically FV only if: (a) observable market price and either (b) can easily be sold or (c) intent to sell.

61. 61 © 2005 IASC Foundation, all rights reserved. Possible Simplifications  IAS 39 – Hedging  General view: Simplification of hedge accounting needed. Views divided:  In SME standards deal only with FX forwards (possibly also simple interest hedging).  Some would have fallback to IAS 39 for other hedges. Others would substitute disclosure for fallback.  Some would recognise derivatives only at settlement (deferral of FV change on hedging instrument), unless speculative.

62. 62 © 2005 IASC Foundation, all rights reserved. Possible Simplifications  IAS 39 – Derecognition  General view: Major simplification needed.  Need examples of factoring.  No “continuing involvement approach”. Instead, no derecognition if any continuing involvement.

63. 63 © 2005 IASC Foundation, all rights reserved. Possible Simplifications  IAS 40 – Investment property  General view: No major simplification needed.

64. 64 © 2005 IASC Foundation, all rights reserved. Possible Simplifications  IAS 41 – Agriculture  General view: FV through P&L model is a burden for SMEs.  Allow cost model option.  Only cost model.  Restrict FV model to observable market prices.  If FV model required, simplify measurements (eg use national average FVs).

65. 65 © 2005 IASC Foundation, all rights reserved. Possible Simplifications  IFRS 1 – First time adoption  General view: Retrospective is difficult for SME. Simplification needed.

66. 66 © 2005 IASC Foundation, all rights reserved. Possible Simplifications  IFRS 2 – Share-based payment  General view: Find simpler valuation model. Examples:  SME use market average volatility.  SME use intrinsic value method.  SME use minimum value method (no volatility).

67. 67 © 2005 IASC Foundation, all rights reserved. Possible Simplifications  IFRS 5 – Assets held for sale  General view: Major simplification needed.  General rule should be assets held for sale at FV only if observable market price.  Some would exempt SMEs from IFRS 5. Just follow IAS 36.

68. 68 © 2005 IASC Foundation, all rights reserved. Next Steps Please understand that these dates are tentative:  Exposure Draft – 1 st half of 2006  Field tests?  Final Standard – 1 st half of 2007  Effective – 2008

69. 69 © 2005 IASC Foundation, all rights reserved. Thank you.