IFRS for Small and Medium-sized Entities
[This summary includes items discussed on the morning of 22 September 2006.]
The Board continued its discussions of a draft Exposure Draft (ED) of an International Financial Reporting Standard for Small and Medium-sized Entities (IFRS for SMEs).
The Board considered a revised draft of ED Section 12 Financial Assets and Financial Liabilities. That draft reflects comments of the Board on the version of Section 12 discussed at the July 2006 meeting, as well as suggestions made by two independent expert reviewers.
An SME would have a choice of applying Section 12 or IAS 39 in accounting for financial instruments. Section 12 simplifies the provisions of IAS 39 in a number of respects, including:
- Two categories of financial assets rather than four.
- Three types of financial instruments will be measured at cost or amortised cost when certain conditions are met. These are (a) receivables, payables, and loans, (b) most commitments to make or receive loans, and (c) equity instruments whose fair value cannot be reliably measured and options on such instruments. Categories (a) and (b) may optionally be at fair value through profit or loss. All other types of financial instruments will be measured at fair value through profit or loss.
- Section 12 includes a clear and simple principle for derecognition - if the transferor has any significant continuing involvement, do not derecognise. As a result, derecognition would be allowed in fewer circumstances than under IAS 39. However, staff does not expect this to be a problem for most SMEs. For one thing, banks and other financial institutions will be prohibited from using the IFRS for SMEs, so the fact that many securitisations may not result in derecognition is not likely to affect most SMEs unfavourably. Another simplification is that the complex 'pass-through testing' and 'control retention testing' of IAS 39 are avoided. Further, an SME can always choose to use IAS 39 instead of Section 12.
- For hedge accounting, Section 12 addresses the four kinds of risk hedges that SMEs typically do. Hedge accounting is not allowed for any other kinds. Additionally Section 12 imposes strict conditions on the designation of a hedging relationship. The benefit for the SME is that if the SME meets those conditions, hedge accounting provisions are greatly simplified.
The draft of Section 12 included two alternative approaches to hedge accounting simplification. One would impose strict conditions on the designation of a hedging relationship with subsequent hedge effectiveness assumed without need for measuring ineffectiveness. The other would (a) relax the conditions for designating a hedging relationship somewhat and (b) require periodic measurement and recognition of ineffectiveness for all hedging activities, but would not require as a qualifying condition that the hedging relationship be effective within a range of 80% to 125%. IAS 39 has such an 80%-125% condition, requiring somewhat complex and retrospective calculations.
The Board discussed those two approaches and also a third approach. The third approach would be not to include any hedge accounting provisions in Section 12 but, instead, to refer SMEs to the hedge accounting provisions of IAS 39 if they wish to do hedge accounting.
After discussion, the Board concluded that in the ED Section 12 should reflect the first approach (effectiveness assumed) and that the Invitation to Comment in the ED should describe the second approach (simplified effectiveness measurement) in detail. Respondents should be invited to express their views regarding the two approaches.
The Board also asked the staff to revise Section 12 as follows:
- Clarify that futures contracts can be hedging instruments.
- Clarify that options cannot be hedging instruments.
- Add guidance on whether and how an SME could change from following Section 12 to following IAS 39 and vice versa.
The Board also agreed that Section 12 should include an appendix of fair valuation guidance from IAS 39.
The Board discussed a revised draft of Section 29 Income Taxes of the ED. Under that draft, an SME would be required to recognise deferred income taxes on all items of income or expense that are recognised in profit or loss or in equity in one period but, under tax laws or regulations, are included in taxable income in a different period (sometimes called 'timing differences'). An SME would also recognise deferred taxes arising from tax losses and tax credits that, under the law, are available to offset taxable profit or tax payable in future periods, although technically these are not timing differences.
Staff characterised this approach as a 'timing differences plus' approach.
Board members generally agreed that deferred taxes should be recognised on all or most timing differences and on tax loss/credit carryforwards. However, some Board members felt that deferred taxes should be provided in more circumstances than just timing differences and carryforwards (including differences between the tax basis and carrying amount that arises when an asset or liability is initially acquired). And some Board members felt that - consistent with IAS 12 Income Taxes - Section 29 should take a 'temporary differences' approach, rather than a 'timing differences plus' approach.
The draft of Section 29 proposed that an SME should not recognise deferred taxes on differences between the tax basis and the carrying amount of assets and liabilities that arise at initial recognition of those assets or liabilities - whether acquired in a business combination or in another transaction. After discussion, the Board did not agree with that proposal. The Board acknowledged that these are not timing differences, but they do create benefits or obligations that meet the definitions of assets and liabilities. The Board asked the staff to revise the draft of Section 29 accordingly.
The Board discussed problems that an SME may encounter in adopting Section 29 for the first time when its previous national accounting framework did not recognise deferred income taxes. The Board agreed that the principle in Section 29 should be that deferred taxes are recognised on differences between the tax basis and the carrying amount of all assets and liabilities. However, the Board also agreed that an exception should be included on first-time adoption of Section 29 when measurement of deferred taxes would require undue cost and effort.
The Board discussed whether an entity should recognise deferred taxes on unremitted earnings of foreign subsidiaries, associates, and interests in joint ventures. The Board concluded that such deferred taxes should not be recognised unless it is probable that the timing difference will reverse in the foreseeable future.
The draft of Section 28 Employee Benefits that the Board had discussed in June 2006 did not include standards on accounting for defined benefit plans. Instead, SMEs were cross-referred to IAS 19 Employee Benefits. At that meeting, the Board concluded that because many SMEs provide benefits under deferred benefit plans or government-mandated programmes that are similar to defined benefit plans, Section 28 should include guidance on defined benefit plan accounting directly, rather than by cross-reference to IAS 19.
The revised draft of Section 28 discussed at the September 2006 meeting included new paragraphs addressing defined benefit plans. Those paragraphs were based on the relevant paragraphs in IAS 19.
The Board agreed that an SME should be required to use the projected unit credit method to determine the present value of its defined benefit obligations and the related current service cost and, where applicable, past service cost. That actuarial method is generally consistent with the asset and liability definitions and recognition provisions of the IASB Framework.
The draft of Section 28 proposed that an SME should recognise actuarial gains and losses in their entirety either in profit or loss or directly in retained earnings, and that the non-recognition and partial recognition (spreading) options of IAS 19 should not be included in the IFRS for SMEs. The Board agreed that the non-recognition and partial recognition options of IAS 19 should not be included in Section 28. However, the Board did not agree with allowing an option to recognise actual gains and losses directly in retained earnings. The Board asked the staff to revise Section 28 to recognise actuarial gains and losses in their entirety in profit or loss. Similar treatment will apply to actuarial gains and losses arising in connection with other long-term benefits. Also, an SME should recognise increases or decreases in past service in their entirety in profit or loss when they arise.
The Board decided to add an exclusion, in Section 13 Inventories, that Section 13 does not apply to the measurement of inventories held by:
- producers of agricultural and forest products, agricultural produce after harvest, and minerals and mineral products, to the extent that they are measured at net realisable value (above or below cost) through profit or loss; or
- commodity brokers and dealers who measure their inventories at fair value less costs to sell through profit or loss.
In the criteria for recognising a provision in Section 21, clarify that probability must be assessed only with respect to transfer of economic benefits. Also, add guidance from paragraph 15 of IAS 37 Provisions, Contingent Liabilities and Contingent Assets on what to do in the rare cases when it is not clear whether there is a present obligation.
Include in Section 23 Revenue guidance on accounting for construction contracts, rather than requiring SMEs always to look to IAS 11 Construction Contracts.
- Section 27 Impairment of Non-financial Assets should address how to allocate an impairment loss to individual assets when a group of assets is tested for impairment.
- Include in Section 27 the guidance on how to measure goodwill impairment, rather than cross-referring to paragraphs 80-99 of IAS 36 Impairment of Assets.