Accounting Standards for Small and Medium-sized Entities (SMEs)
The session primarily focussed on section 12 Financial Assets and Financial Liabilities of a draft Exposure Draft of an IFRS for SMEs. However, before that, staff presented a brief summary of the project's progress. Most of the 40 sections of the draft IFRS for SMEs have been tentatively approved. The main outstanding sections to be drafted are those on income taxes and employee benefits. In addition, the basis for conclusions and invitation to comment also need to be drafted.
Before looking at the financial instruments section, the Board briefly considered the approach being taken to accounting for income taxes. Staff proposed using a timing difference approach. There was support for this, although some Board members were concerned that certain assets and liabilities that should be recorded would be missed.
The remainder of the time was spent considering section 12 of the draft SME IFRS> Section 12 contains substantial re-drafts based on decisions taken at the June Board meeting. However, the full text of section 12 was not made available to observers.
At the June meeting, the Board tentatively agreed that an SME should not have the option to use IAS 39 instead of section 12. However, whilst section 12 adopts a simpler way of accounting for financial instruments than IAS 39, the simplifications mean that many of the options available in IAS 39 would not be available to SMEs (for example, the available-for-sale and held-to-maturity classifications for financial assets). Furthermore, certain assets that could be carried at amortised cost under IAS 39 would have to be carried at fair value through profit and loss under section 12, and the derecognition provisions of section 12 are simpler but stricter than those in IAS 39. As a result, staff asked the Board to reconsider its June decision. The Board agreed that SMEs should have the choice to adopt IAS 39 in full instead of using section 12.
As part of simplifying the requirements on accounting for financial instruments, the reference to categories of financial assets and liabilities has been removed. Instead, staff proposed that the default is for all instruments to be carried at fair value, with changes in fair value recognised in profit or loss. There are three exceptions to this, two of which are optional, and one of which is mandatory:
- 1. 'plain vanilla' receivables, such as trade receivables, payables, and similar instruments (elective);
- 2. commitments to make or receive loans that cannot be net settled and will result in a financial instrument that qualifies for recognition at amortised cost (elective); and
- 3. equity instrument that are not publicly traded and whose fair value cannot be measured reliably, and options on such instruments (mandatory).
Part of the reason for doing this was to eliminate the need to refer to derivatives or embedded derivatives. Some Board members felt it would be better to reverse these paragraphs so that the standard first stated which items could be carried at cost (or amortised cost) and then stated that all other items had to be carried at fair value through profit and loss.
At the June meeting, the Board asked that the guidance in IAS 39 on determining fair values to be included in the draft IFRS for SMEs. The Board also asked that the guidance on impairment be re-written. These changes were processed by the staff and approved by the Board.
The Board was again asked to approve the guidance on derecognition. Broadly, an entity would derecognise an asset when:
- the contractual rights to the cash flows expire; or
- the entity transfers all the significant risks and rewards relating to the asset; or
- the entity transfers physical control of the asset and the transferee can sell the asset to an unrelated third party without restriction.
Whilst the wording had not changed significantly, staff highlighted that the simplified derecognition provisions result in a very high hurdle for derecognition. It is therefore possible that certain securitisations and debt factoring that would qualify for derecognition under IAS 39 would not be derecognised under the IFRS for SMEs. The Board agreed with the derecognition provisions. They pointed out that few SMEs enter into securitisation transactions, and the option to adopt IAS 39 is available to those that do and wish to derecognise.
The proposals for hedge accounting were debated at length. Some members believed that the easiest way of simplifying the hedging rules was to only allow hedge accounting in four identified circumstances and to not account for any ineffectiveness that may arise. The logic is that hedging is limited to circumstances where there is unlikely to be much ineffectiveness. Some call this the 'shortcut method'. Under this proposal, an entity could hedge the following:
- interest rate risk of a debt instrument measured at amortised cost;
- foreign currency exposure in a commitment or highly probably forecast transaction;
- commodity price risk exposure in a commitment or highly probably forecast transaction; and
- foreign exchange risk exposure in a net investment in a foreign operation.
Some Board members proposed an alternative under which effectiveness would have to be measured at each reporting date and any ineffectiveness would be reported immediately in profit or loss - similar to IAS 39 but with simplified calculations.
The Board asked the staff to develop both a shortcut approach and an effectiveness testing approach, and also to consider whether the IFRS for SMEs should permit both of those approaches.