THE IASB’S PROJECT ON ACCOUNTING STANDARDS FOR SMEs

1. THE IASB’S PROJECT ON ACCOUNTING STANDARDS FOR SMEs Presentation by Paul Pacter, IASB Director of Standards for SMEs ACCA Symposium “Beyond 2005: Financial Reporting by Private EU Companies” Brussels, 5 February 2004

2. A BIT OF BACKGROUND • IASC began SME project in April 1998. • Steering Committee discussions, but did not lead to a discussion paper, an ED, Standards, or any other guidance. • Scope of project was unclear. • Transition memo to IASB: IASC cited standards for SMEs as a critical agenda item for the IASB (December 2000). • “A demand exists for a special version of International Accounting Standards for Small Enterprises.”

3. A BIT OF BACKGROUND • IASB research project: 2001. • IASC Foundation 2002 annual report: • “The Trustees support efforts by the IASB to examine issues particular to emerging economies and to small and medium-sized enterprises.”

4. A BIT OF BACKGROUND • IASB Advisory Group appointed: • First meeting was April 2003. • “Sounding Board” for ideas. • I am fairly new to the project: • Started 1 July 2003. • Director, Small and Medium Sized Entities. • Some key decisions made already. • Others close at hand.

5. THE STATUTORY REPORTING ISSUE • In many countries in the world, all or most companies have a statutory (legal) obligation to prepare GAAP financial statements. • Europe: In Europe, we are talking about 5,000,000 SMEs, not just the 9,000 listed companies who will be required to follow IFRS starting in 2005.

6. THE STATUTORY REPORTING ISSUE • These financial statements are made available to creditors, suppliers, owners, governments, and others. • The vast majority of these companies are “small” or “medium sized”, whether we use the EU size criteria or some other definition.

7. THE STATUTORY REPORTING ISSUE • Today, no major developed economy requires these little companies to follow GAAP as rigorous as IFRS. • It is doubtful that any of the IASB’s partner standard setters would support requiring IFRS for these companies.

8. THE STATUTORY REPORTING ISSUE • United States: Statutory reporting issue is not well understood in the USA because the great majority of companies do not have any GAAP reporting obligation whatsoever.

9. THRESHOLD QUESTIONS • Which GAAP should SMEs follow? • And what, if anything, should be the IASB’s role in developing that GAAP?

10. THE POSSIBLE ANSWERS TO THE THRESHOLD QUESTIONS ARE: • If SMEs want to say they follow IFRS, they must follow full IFRS – no special GAAP. • A global GAAP for SMEs should be developed by the IASB. • National jurisdictions can decide which entities are eligible to use. • A global GAAP for SMEs should be developed by another body. • IASB should focus on listed companies. • Each country should develop its own GAAP for SMEs.

11. THRESHOLD QUESTIONS:THE IASB’S ANSWER • The Board decided on choice #2 – that it would develop financial reporting standards for SMEs. • Large majority, but not unanimous. • Some sharp divisions within the Board and staff leadership on whether SME-GAAP is needed – and, if it is developed, what is the justification for making any changes from IFRS.

12. THRESHOLD QUESTIONS: THE IASB’S ANSWER • The Board also said those standards should: • Reduce the financial reporting burden on SMEs. • Be built on the same concepts as IFRSs. • Allow easy transition to full IFRSs for those SMEs that grow. • Focus on meeting the needs of users of SME financial reports.

13. Same conceptual framework as IFRS. Start by extracting principles from IFRSs. Modifications based on needs of users of SME financial statements. Disclosure and presentation modifications are likely to be justified based on user needs. FUNDAMENTAL DECISIONS THAT THE BOARD HAS ALREADY MADE

14. Rebuttable presumption of no recognition and measurement modifications. Can only be overcome based on user needs and cost/benefit analysis. If IASB SME GAAP does not address an issue, full IFRS would be a mandatory fallback.. FUNDAMENTAL DECISIONS THAT THE BOARD HAS ALREADY MADE

15. Publish IASB SME GAAP in a separate printed volume. IASB SME standards should follow the IAS/IFRS numbering system -- that is: SME-IAS 1, SME-IAS 2, etc. and SME-IFRS 1, SME-IFRS 2, etc. Not reorganised by topic (such as integrated in a balance sheet - income statement line item sequence like the UK FRSSE). FUNDAMENTAL DECISIONS THAT THE BOARD HAS ALREADY MADE

16. FUNDAMENTAL DECISIONS THAT THE BOARD HAS ALREADY MADE • Decisions – Definition of an SME: • Board should describe the characteristics of entities for which it intends the SME standards. • No quantitative size test. • National jurisdictions should determine which entities are eligible to use IASB SME standards.

17. FUNDAMENTAL DECISIONS THAT THE BOARD HAS ALREADY MADE • Decisions – Definition of an SME (continued): • Full IFRS should be regarded as suitable for all entities. • As an alternative, IASB will develop SME GAAP for those entities that do not have a public accountability.

18. FUNDAMENTAL DECISIONS THAT THE BOARD HAS ALREADY MADE • An entity is publicly accountable if: • High degree of outside interest from investors or other stakeholders. • Entity has essential public service responsibility due to the nature of its operations. • Substantial majority of stakeholders depends on external financial reporting as they have no other way of obtaining financial information about the entity.

19. FUNDAMENTAL DECISIONS THAT THE BOARD HAS ALREADY MADE • Presumptive indicators of public accountability: • Issues securities in public market. • Holds assets in fiduciary capacity (banks, insurance, brokerage, pension fund, mutual fund, investment bank). • Public utility – essential public service. • Economic significance in jurisdiction in which domiciled. • One or more owners has expressed objection to using SME GAAP.

20. VIEWS OF OTHERS • The “outside world” seems very much in favour of a separate set of SME GAAP developed by the IASB: • IASB Advisory Group: 10 out of 12 • World Standard Setters: Overwhelmingly in favour. I will comment on the results of my survey in a moment. • UNCTAD, CAPA, EC, EFRAG, many other international and regional organisations as well.

21. RESPONSES TO OUR SURVEY • Survey of World accounting standard setters (WSS) before their September 2003 London meeting. • Two objectives: • Learn what is already being done around the world to reduce the financial reporting burden on SMEs. • Seek WSS views on what the IASB should do.

22. RESPONSES TO OUR SURVEY 30 Respondents: Iran Italy Japan Korea Malaysia Moldova Netherlands New Zealand Norway Pakistan Poland Russia Singapore South Africa Spain Sri Lanka Sweden Thailand UK USA Australia Canada China Denmark EFRAG France Germany Hong Kong Hungary Indonesia

23. WHAT COUNTRIES ARE NOW DOING FOR SMEs • Statutory GAAP reporting obligation imposed for: • All companies: 20 countries. • All companies above a certain size: 8 countries. • Only listed companies: 2 countries.

24. WHAT COUNTRIES ARE NOW DOING FOR SMEs • Separate SME GAAP • 10 countries. • No Separate SME GAAP: • 18 countries. But… • 15 of the 18 have SME exemptions in their basic GAAP • 5 of the 18 are now developing separate SME GAAP • 5 of the 18 have “de facto” SME GAAP because of national laws.

25. WHAT COUNTRIES ARE NOW DOING FOR SMEs • When SME GAAP is followed, what does the auditor’s report say? • Generally retains the “true and fair view” or “presents fairly” wording. • Majority of countries – auditor’s report refers to SME GAAP. • Minority of countries – auditor’s report simply refers to GAAP. • IASB’s issue is the basis of presentation note, not the auditor’s report.

26. WHAT COUNTRIES ARE NOW DOING FOR SMEs • Does your primary GAAP have disclosure and presentation differences for SMEs? • Yes: 27 countries. • No: 3 countries.

27. WHAT COUNTRIES ARE NOW DOING FOR SMEs • Examples (present. and disclosure): • Abbreviated FS and reduced notes. • Omit cash flow statement. • Omit statement of equity. • Omit statement of comprehensive income. • Exempt from consolidated FS. • Omit reconciliations of tangible and intangible assets.

28. WHAT COUNTRIES ARE NOW DOING FOR SMEs • More examples (disclosure): • Omit FV disclosures for Financial Instrumts. • Omit Segments, EPS, Discontinued Ops. • Omit note disclosures on provisions, impairments, related parties, accruals and deferrals, taxation, depreciation, asset reconciliations, contingencies, inventories, cost of sales, remuneration, asset disposals, production data, exports, interim reports, employees, derivatives, R&D, pensions, OPEBs.

29. WHAT COUNTRIES ARE NOW DOING FOR SMEs • Does your primary GAAP have recognition and measurement differences for SMEs? • Yes: 18 countries. • No: 12 countries. • Examples: • Income taxes – tax payable method. • All leases are operating. • Simplified pension calculations. • Simplified impairment calculations.

30. WHAT COUNTRIES ARE NOW DOING FOR SMEs • More examples (recog. & measurement): • Exempted from equity accounting. • Tax depreciation rates. • Inventory based on net SP minus profit. • Very small co: cash basis of accounting. • Not use % of completion method. • FX at settlement amount (no gain or loss). • Allow pooling for small company mergers. • No fair value for investment property. • Do not capitalise development costs.

31. WHAT SHOULD IASB DO? • Should IASB provide presentation and disclosure simplifications? • Yes: 29 countries. • No: 1 country. • Should IASB provide recognition and measurement simplifications? • Yes: 24 countries. • No: 6 countries.

32. WHAT SHOULD IASB DO? • Cited reasons - those saying yes: • Existing IFRS are aimed primarily at info needs of public capital markets: 25 • SMEs lack accounting expertise: 23 • Different user needs: 19 • SMEs report to owner/managers: 19 • Cost of full IFRS exceeds benefits: 3

33. WHAT SHOULD IASB DO? • Cited reasons - those saying no: • Assets, liabilities, income, expenses should be recognised and measured the same way for all entities: 6 • Nature of transaction should determine how it is accounted for, not size of entity entering into transaction: 5 • All users have same info needs: 4 • SMEs have complex transactions too: 4 • Competing frameworks and standards: 4

34. WHAT SHOULD IASB DO? • How should IASB publish SME GAAP? • Within each individual IFRS: 5 countries. • Separate, combined, stand-alone document: 16 countries. • Both: 7 countries.

35. WHAT SHOULD IASB DO? • How to label IASB SME GAAP? • “in conformity with IFRS” - 4 countries. • “in conformity with IFRS applicable to SMEs” - 22 countries. • “in conformity with IFRS level II” - 1 country • Find a term that does not include IFRS - 1 country. • “in conformity with the recognition and measurement requirements of IFRS but not the presentation and disclosure requirements” - 1 country.

36. EXTRACTING PRINCIPLES FROM IFRS HAS BEGUN • I presented a draft SME version of IAS 19, Employee Benefits, to the Board in October. • What I did: • All black letter principles extracted from IAS 19. • Plus a few “principles” that are not in black letter.

37. EXTRACTING PRINCIPLES FROM IFRS HAS BEGUN • What I did (continued): • Presented in 2-column format: • Left: Proposed SME Principles. • Right: Explanation of source and any change from IAS 19. • Proposed a good number of disclosure reductions plus some recognition and measurement simplifications.

38. EXTRACTING PRINCIPLES FROM IFRS HAS BEGUN • What I did (continued): • Recognition and measurement simplifications: • Discounting required if > one year. • Measure non-monetary benefits at cost. • Flexibility in using Projected Unit Credit. • Actuarial gains: allow 2 methods (immediate or spread over 10 years).

39. EXTRACTING PRINCIPLES FROM IFRS HAS BEGUN • What I did (continued): • Omitted some IAS 19 principles: • Multi-employer, state, insured plans. • Asset ceiling test. • Regularity of valuation. • Reimbursement rights. • Curtailments and settlements. • Mixed reaction from the Board to measurement simplifications and omissions. • Asked for user needs justification.

40. INFORMAL USER PANEL • Groups invited to advise on proposed simplifications from user perspective: • Assn. for Investment Mgt. and Research • Risk Management Assn (was Robert Morris) • British Bankers Association • European Priv. Equity & Venture Capital Asn. • Security Analysts Societies of Japan, India, and China • European Fed. Financial Analysts Societies • European Banking Federation. • Hong Kong Assn. of Banks

41. TIMETABLE • Begin sending draft SME standards to IASB in February. • Several already being reviewed by the Advisory Panel. • Goal is Exposure Draft of the whole package by end of 2004.

42. WHAT ABOUT EMERGING ECONOMIES? • Initial phase of project focusing on SMEs. • SME standards will be of relevance and benefit in Emerging Economies (EEs). • Whether further special work is needed for EEs remains to be seen.

43. YOUR VIEWS? • I welcome views of the audience on: • Recognition and measurement simplifications. • Mandatory fallback to IFRS. • Requiring unanimous owner agreement. • How to label IASB SME GAAP. • The term SME. • Organising IASB SME standards by IAS/IFRS numbering system. • Any other issues. • Thank you for inviting me.