The Chartered Accountant Journal Vol. 69 | No. 3 | September 2020 | Pages 65–71 (Journal pp. 337–343)

Path Ahead for IFRS for SMEs Standard

By CA. Nikita Bothra & CA. Savita Gupta  |  Members of the Institute (nikita.bothra@icai.in, eboard@icai.in)

Aligning the IFRS for SMEs Standard with full IFRS Standards

In January 2020, the International Accounting Standards Board (IASB) issued a Request for Information (RFI) as a first step towards the second Comprehensive Review of the IFRS for SMEs Standard, for comments from stakeholders. Comments are sought on whether and how the IFRS for SMEs Standard should be amended to take account of IFRS Standards and amendments to IFRS Standards.

What is International Financial Reporting Standard for Small and Medium-sized Entities (IFRS for SMEs)?

The types and needs of users of SME financial statements are fundamentally different from the types and needs of users of financial statements of entities that are publicly accountable and use full IFRS. Users of the financial statements of SMEs are more interested in knowing short-term cash flows, liquidity, balance sheet strength, interest coverage, and solvency issues.

Full IFRS impose an onerous burden on SME preparers because they contain complex topics and detailed implementation guidance in many areas that are simply not relevant to SMEs. This compliance burden becomes significantly higher as full IFRS Standards become increasingly granular and detailed.

Therefore, a significant need existed for an accounting and financial reporting standard for SMEs that would meet the specific information needs of their financial statement users while balancing the costs and benefits from a preparer perspective. The IFRS for SMEs was designed specifically to meet that need.

In this view, on 9th July 2009, the IASB issued the IFRS for SMEs Standard, which represents the first set of international accounting requirements developed specifically for SMEs. Though it has been prepared on the basis of full IFRS, it is a stand-alone product separate from the full set of IFRS. The Standard is a product of a rigorous 5-year development process with extensive worldwide consultation of SMEs. It is intended for entities that prepare general purpose financial statements (GPFS) except those entities whose securities are publicly traded and financial institutions, such as banks and insurance companies.

Figure 1: Scope and Applicability of Financial Reporting Frameworks

Full IFRS Standards Approximately 2,400 pages*
Publicly Accountable Entities
↓
IFRS for SMEs Standard Approximately 240–250 pages* (35 Sections)
Entities NOT Publicly Accountable but Require GPFS
↓
No Requirement for GPFS IFRS Not Required
Financials for Tax Authorities or Partners
*Excluding Basis for Conclusions and supporting implementation guidance.

Architecture, Simplifications & Global Adoption

Global Footprint: As on date, 86 out of 166 jurisdictions require or permit the use of the IFRS for SMEs Standard.

With the issuance of IFRS for SMEs, many SMEs around the world have the option of using a much simplified, IFRS-based accounting framework to prepare their financial statements. The IFRS for SMEs Standard comprises 250 pages, is divided into 35 thematic sections, and includes a preface and an exhaustive glossary. While rooted firmly in the fundamental principles of full IFRS Standards, the IFRS for SMEs Standard reflects five major structural simplifications:

  • Omission of complex topics: Some topics in full IFRS Standards are omitted completely because they are not relevant to typical SMEs (e.g., earnings per share, interim reporting, segment reporting).
  • Restricting accounting policy options: Some accounting policy options permitted under full IFRS Standards are disallowed because a single, simplified benchmark method is available to SMEs (e.g., expensing all borrowing and R&D costs).
  • Simplification of recognition and measurement: Many of the recognition and measurement principles that exist in full IFRS Standards have been significantly simplified (e.g., amortisation of goodwill, cost model for intangibles).
  • Substantially fewer disclosures: Disclosures are curtailed drastically to reflect only information genuinely demanded by lenders, credit rating agencies, and SME stakeholders.
  • Drafting in plain English: The text of full IFRS Standards has been completely redrafted in ‘plain English’ for ease of translation, interpretation, and grassroots adoption.

Comparative Review Cycles & Implementation Roadmap

First Comprehensive Review (2015 Amendments)

  • IASB completed its first comprehensive review of the IFRS for SMEs Standard in May 2015.
  • Some new IFRS Standards and amendments to IFRS Standards were considered by the IASB during this cycle.
  • Considering the fact that the IFRS for SMEs Standard was then a relatively new Standard, the IASB issued only limited amendments to avoid destabilizing early preparers.
  • The amendments were made effective w.e.f. 1 January 2017, with early application permitted.

Second Comprehensive Review (2020 Review)

  • The Request for Information (RFI) on the Comprehensive Review of the IFRS for SMEs Standard is the first operational step by the IASB in its second comprehensive review.
  • Published by the IASB in January 2020 for public comments originally due by 27th October 2020.
  • Comments are specifically sought on whether and how the IFRS for SMEs Standard should be amended to take account of major new IFRS Standards, amendments, and IFRIC Interpretations.

Figure 2: Second Comprehensive Review – Timeline & Milestones

2015
Issued amended IFRS for SMEs (effective 1 Jan 2017)
→
2019
Second Comprehensive Review commenced
→
2020 Q1
Phase I: Publish RFI (Jan 2020)
→
2020 Q4
Public Comment Deadline (Oct 27, 2020)
→
Next Milestone
Phase II: Global Feedback Analysis

Scope and Trilateral Structure of the Second Comprehensive Review

Substantive Scope of the Review

The substantive scope examined under the RFI encompasses three distinct technical sources:

  • IFRS Standards, amendments to IFRS Standards, and IFRIC Interpretations issued since the first comprehensive review of the IFRS for SMEs Standard;
  • IFRS Standards and IFRIC Interpretations issued before the first comprehensive review, but that did not result in amendments to the IFRS for SMEs Standard at that time; and
  • General implementation experience and practical issues arising from the application of the IFRS for SMEs Standard across adopting jurisdictions.

Note: The IASB explicitly clarified that it is not seeking views on the fundamental scope of the IFRS for SMEs Standard itself as part of this second comprehensive review.

Three-Part Structure of the Second Comprehensive Review

Part A Strategic approach and general framework to align with full IFRS Standards.
Part B Aligning specific sections of the IFRS for SMEs Standard with corresponding IFRS.
Part C New topics and other emergent financial reporting matters (e.g., cryptocurrencies).

Part A – Strategic Approaches and Alignment Principles

Part A sets out the overarching framework developed by the IASB for approaching the second comprehensive review and solicits public feedback on its strategic orientation. Two competing philosophical approaches were evaluated:

Simplified IFRS Standard Approach (Adopted by IASB)
  • Aligns the IFRS for SMEs Standard systematically with full IFRS Standards.
  • Allows the immense experience gained from developing full IFRS Standards to be utilized efficiently.
  • Remains consistent with the expectation that the IFRS for SMEs Standard reflects the same fundamental principles as full IFRS Standards.
  • Provides sufficient flexibility to allow the specific requirements and operational characteristics of SMEs to be addressed.
Independent Standard Approach (Alternative)
  • Updates the IFRS for SMEs Standard only for specific standalone issues arising directly from the application of the Standard.
  • Maintains that the IFRS for SMEs Standard should be developed and amended considering only the explicit and isolated requirements of SMEs, without reference to changes in full IFRS.

The Three Core Alignment Principles

In pursuing the simplified IFRS alignment approach, the IASB decided to apply three filtering principles to determine whether, when, and how specific full IFRS requirements should be aligned:

1. Relevance

Core Test: Is the topic relevant to SMEs?
Assesses whether the problem addressed under full IFRS would make a difference in the economic decisions of users of SME financial statements. Involves determining whether the issue belongs in the scope of review and whether changes exceed the appropriate level of detail for SMEs.

2. Simplification

Core Test: Can the requirements of full IFRS be simplified?
Simplifies recognition/measurement, curtails disclosure volume, and refines drafting into plain language. Applying simplicity involves reviewing Standards meeting relevance and identifying suitable simplifications across 5 proven modalities.

3. Faithful Representation

Core Test: Do outcomes faithfully represent transactions in words & numbers?
Assesses whether simplified financial statements would faithfully depict the economic substance of transactions. If simplified rules produce distorted representations, the quality of reported financial information is damaged.

Five Modalities for Simplifying Full IFRS Requirements

  1. (a) Omitting some topics: Eliminating entire sections that do not apply to typical SMEs.
  2. (b) Permitting only the simplest option: When a full IFRS Standard permits accounting policy choices, permitting only the single most straightforward alternative.
  3. (c) Simplifying recognition and measurement requirements: Replacing complex valuation techniques with practical cost-based approximations.
  4. (d) Reducing disclosures: Pruning disclosure requirements strictly to primary user priorities.
  5. (e) Simplifying language: Replacing dense legalistic jargon with concise plain English prose.

Practical Application of Alignment Principles: The Lease Accounting Model

Relevance Dimension Proposed Simplification Solutions Faithful Representation Test
High Relevance for SMEs: Leasing is widely used by SMEs globally and is officially ranked as their third most important source of external financing.
  • Requiring a single on-balance sheet model for lessee lease accounting;
  • Introducing practical recognition exemptions for short-term leases and leases of low-value assets;
  • Simplifying the requirements for measuring variable lease payments, determining discount rates, determining and reassessing lease terms, and subsequent remeasurement of lease liabilities;
  • Retaining existing concise disclosures for finance leases;
  • Simplifying the language of the entire lease section.
 Evaluation: The IASB considered whether financial statements prepared using these simplified lease requirements would faithfully represent an entity’s lease assets and liabilities without undue operational complexity.
Table 1: Operational Application of Alignment Principles to Lease Accounting (IFRS 16 Alignment)

When (Date) to Consider Alignment with New IFRS Standards

Public views are sought on how soon after the introduction of an IFRS Standard, an amendment, or an IFRIC Interpretation should the changes be incorporated into the IFRS for SMEs Standard. Four timing options are proposed:

Option 1: Issued before publication date of Request for Information.
Option 2: Effective before publication date of Request for Information.
Option 3: Effective and on which post-implementation review (PIR) was completed before RFI publication.
Option 4: Based on some other customized or phased transition date.

Part B – Aligning Specific Sections with Major IFRS Standards

Part B of the RFI poses detailed technical questions regarding specific sections of the IFRS for SMEs Standard that are being considered for alignment with newly issued or amended full IFRS Standards and interpretations:

S.No Topic & SME Section Detailed Comments & Options Sought by IASB
1. Conceptual Framework for Financial Reporting
(Section 2 – Concepts and Pervasive Principles) 		• Whether to align the IFRS for SMEs Standard with the 2018 Revised Conceptual Framework for Financial Reporting.
• Whether to retain the crucial overarching concept and relief of ‘undue cost or effort’ throughout the IFRS for SMEs Standard.
2. Consolidated Financial Statements & Joint Arrangements
(Section 9 – Consolidated and Separate Financial Statements; Section 15 – Joint Ventures) 		• Whether to align the definition of ‘control’ (IFRS 10) and ‘joint control’ (IFRS 11) in the IFRS for SMEs Standard with the definitions in full IFRS.
• Whether to retain the practical simplification in IFRS for SMEs stating that control is presumed to exist when the parent entity owns, directly or indirectly through subsidiaries, more than half the voting power.
• Whether to retain the existing three categories of joint arrangements (jointly controlled operations, assets, and entities) along with their accounting choices.
3. Leases
(Section 20 – Leases) 		• Whether to align the IFRS for SMEs Standard with the landmark IFRS 16 Leases standard, introducing a single lessee model on-balance sheet with simplified measurement and recognition exemptions.
4. Revenue from Contracts with Customers
(Section 23 – Revenue) 		Evaluating three possible approaches to align Section 23 with IFRS 15:
1. Update: Update IFRS for SMEs Standard to align outcomes with IFRS 15 principles;
2. Rewrite: Fully rewrite Section 23 of the IFRS for SMEs Standard to mirror the 5-step model of IFRS 15 with simplifications;
3. Defer: Wait until the next comprehensive review cycle before undertaking major revenue modifications.
5. Fair Value Measurement
(Section 2 – Concepts and Pervasive Principles) 		• Whether to align the definition of fair value with IFRS 13 Fair Value Measurement (exit price perspective).
• Whether to consolidate guidance on fair value measurement into a single section and incorporate the principles of the three-level fair value hierarchy set out in full IFRS.
6. Business Combinations and Goodwill
(Section 19 – Business Combinations and Goodwill) 		• Whether to include explicit accounting requirements for step acquisitions in IFRS for SMEs Standard and align them with full IFRS 3.
• Whether to align the definition of a ‘business’ with the amendments to IFRS 3 issued in October 2018 (narrowed definition and optional concentration test).
7. Financial Instruments
(Section 11 – Basic Financial Instruments; Section 12 – Other Financial Instruments Issues) 		• Whether to align with IFRS 9 Financial Instruments by supplementing the illustrative list with a principle based on contractual cash flow characteristics (SPPI test).
• Whether to introduce the simplified expected credit loss (ECL) approach for impairment of trade receivables, replacing the backward-looking incurred loss model.
• Whether to introduce modern hedge accounting requirements or retain existing hedging rules.
• Whether to update the current option that permits entities to apply the recognition and measurement rules of IAS 39 with an option to apply IFRS 9.
Table 2: Specific Accounting Topics Examined for Alignment in Part B of the RFI

Part C – Emerging Topics, Crypto-Assets & Public Consultation

Part C seeks views on critical topics that are currently not addressed in the IFRS for SMEs Standard and examines whether specific guidance should be added, or whether alignment should be deferred:

IFRS 14: Regulatory Deferral Accounts

IFRS 14 addresses regulatory deferral account balances arising when goods or services are subject to statutory rate regulation. Currently, IFRS for SMEs contains no corresponding section. While rate-regulated SMEs exist, the IASB is considering not aligning with IFRS 14 because it is an interim standard likely to be superseded by the IASB’s active Rate-regulated Activities project.

Defined Benefit Obligation Simplifications

Section 28 permits an entity to ignore estimated future salary increases, future service, and mortality in service when valuing defined benefit obligations if applying the Projected Unit Credit (PUC) method involves ‘undue cost or effort’. The IASB is gathering empirical data on how frequently this simplification is utilized and whether practical difficulties arise.

Cryptocurrency and Crypto-Assets

The IASB is seeking market data to ascertain whether holdings of cryptocurrencies and issuances of crypto-assets are prevalent among entities applying the IFRS for SMEs Standard. This evidence will determine whether explicit accounting rules are warranted or whether general principles suffice.

Other Unaddressed Topics & Section 10 Guidance

Section 10 provides a hierarchy for management judgment in developing accounting policies when the Standard does not address a topic. The IASB is seeking input on whether there are specific unaddressed transactions where the general hierarchy in Section 10 proves insufficient and dedicated standards are needed.

The second comprehensive review of the IFRS for SMEs Standard provides an unprecedented opportunity to align global SME reporting with major IFRS breakthroughs (IFRS 9, 15, 16) while preserving essential cost-benefit simplifications, plain language readability, and relief from undue administrative burdens.