U.S. SMEs should consider commenting on IASB's proposal for SMEs.

On June 18, the International Accounting Standards Board (IASB) announced that it was beginning field testing of its proposal on the accounting for small and medium-sized entities (SMEs) that had been issued earlier this year. The exposure draft (ED), a Proposed International Financial Reporting Standard for Small and Medium-sized Entities, is available on the IASB's website, www.isab.org.uk, along with comments that are due Oct. 1.

The press release quoted IASB Chairman Sir David Tweedie saying, "The field test will suggest how we can improve our proposals and identify areas for further simplification, if possible." IASB plans to use the field testing program to assess the scope, impact and burden of the proposed International Financial Reporting Standards (IFRS) for SMEs.

Overall, the IASB proposal is an attempt to develop a solution to the problems facing SMEs on how to deal with the sheer volume and undue complexity of existing international accounting standards. Most knowledgeable commentators believe that only the most sophisticated of entities can assemble the talent and resources necessary to adequately implement and apply, on an ongoing basis, the existing universe of international accounting standards.

There are over 25,000 pages of U.S. accounting guidance--including materials issued by the Financial Accounting Standards Board (FASB), the American Institute of Certified Public Accountants (AICPA) and the U.S. Securities and Exchange Commission (SEC)--as compared to the over 2,500 pages of international guidance published by IASB.

IASB's SME proposal, at slightly over 250 pages, is an attempt to reduce to a more manageable level the accounting guidance that SMEs must typically follow. IASB considers the typical SME to have approximately 50 employees with revenues and assets in the $10 million-to-$25 million range. While it is a proposed solution to the dilemma SMEs face, it is not the first "slice of the apple" in trying to solve this intractable problem and possibly not the best solution.

SME Solutions: Background

To understand this thinking, it is necessary to review some history. At its 17th annual session in July 2000, the Intergovernmental Working Groups of Experts on International Standards of Accounting and Reporting (ISAR) of the United Nations Conference on Trade and Development (UNCTAD) discussed the obstacles that SMEs faced in applying accounting standards that had been issued by various standard-setting bodies, both national and international.

At that meeting, it was agreed that a project should be undertaken to identify possible approaches that would meet the accounting and reporting needs of SMEs.

IASR concluded that the standards developed by IASB really only applied to entities that are public companies, not those existing in developing countries and countries with economies in transition. Over the next four years, IASR developed and, published (in 2004) 60 pages of guidance titled, Accounting and Financial Reporting Guidelines for Small and Medium-Sized Enterprises (SMEGA) Level 2 Guidance. The document is available on the UNCTAD website, www.unctad.org. The three-tiered structure IASR proposed be adopted includes:

Level 1. This level would apply to listed enterprises whose securities are publicly traded and those in which there is significant public interest. These enterprises should be required to apply the accounting and financial reporting standards issued by IASB, International Accounting Standards (IAS) and IFRS.

Level 2. This level would apply to significant business enterprises that do not issue public securities and in which there is no significant public interest. IASR has developed a single set of requirements derived from the IAS issued by IASB, but embodying only requirements for the most regularly encountered transactions. This level would still have the option to follow the full set of IAS and IFRS.

Level 3. This level would apply to the smallest entities, which are often owner-managed and have few employees. The approach proposed is a simple accruals-based accounting, based on that set out in IAS, but closely linked to cash transactions. A derogation would, however, be permitted within this level for businesses to use cash accounting for a limited time when first establishing their accounting systems.

For Level 2, IASR proposed guidelines for the preparation of general purpose financial statements of SMEs in developed and developing countries as well as in economies in transition. Such statements would be prepared at least annually and are intended to meet the information needs of a wide range of users. SMEGA for Level 2 SMEs is based on IAS and Interpretations in existence in 2002 and includes these standards:

No.  Subject

 1   Presentation of Financial Statements
 2   Inventories
 7   Cash Flow Statements
 8   Accounting Policies, Changes in Accounting Estimates and Errors
10   Events after the Balance Sheet Date 12 Income Taxes
16   Property, Plant and Equipment
17   Leases
18   Revenue
20   Accounting for Government Grants and Disclosure of Government
     Assistance
21   The Effects of Changes in Foreign Exchange Rates
23   Borrowing Costs
24   Related Party Disclosures
36   Impairment of Assets
37   Provisions, Contingent Liabilities and Contingent Assets

However, SMEGA for Level 2 SMEs does not include the following standards that, due to their nature, are industry-specific, overly complex or are more geared to public reporting requirements:

No.  Subject
11   Construction Contracts
14   Segment Reporting
19   Employee Benefits
22   Business Combinations
26   Accounting and Reporting by Retirement Benefit Plans
27   Consolidated Financial Statements
28   Accounting for Investments in Associates
29   Financial Reporting in Hyperinflationary Economies
30   Disclosures in the Financial Statements of Banks
31   Financial Reporting of Interests in Joint Ventures
32   Financial Instruments: Disclosure and Presentation
33   Earnings per Share
34   Interim Financial Reporting
35   Discontinuing Operations
39   Instruments: Recognition and Measurement
40   Investment Property
41   Agriculture

The fundamental premise of the Level 2 guidance is that it be as short as possible and it concentrate on measurement approaches that are feasible within an entity's available infrastructure to enable users of the financial information to make informed decisions. Guidance should be user-friendly, understandable and focused on the most frequently encountered transactions, but nevertheless be based on existing IAS to ensure a smooth transition from Level 2 to Level 1 as the entity grows.

One of the keys to SMEGA is that the entity must disclose that it is following SMEGA. Although, due to space constraints, a complete description and analysis of SMEGA is not possible here, preparers and other commentators are urged to actively consider the guidance in this IASR document for further ideas and ways of reducing the accounting complexities facing SMEs.

These ideas should then be combined with those developed from the review and analysis of the current IASB proposal to help develop meaningful input to be sent to IASB so that it can eventually provide a workable solution to SMEs' accounting and reporting issues.

Even if IASB takes the best of both its proposal and SMEGA to develop a workable framework for small and medium-sized entities--those with more than 50 employees--there nevertheless is still an urgent need for an accounting solution for Level 3-type entities--those with 1 to 10 employees--which make up the millions of business entities existing in emerging economies of the world today.

As FASB and IASB continue work on converging financial reporting standards--with the U.S. exhibiting a seemingly compromising mood towards IFRS--what eventually develops from these SME standards may well be what U.S. companies will be living with, come 2009 or so.

There's still time to read the draft IFRS for SMEs and comment by Oct. 1, 2007. The document can be found on the IASB website (www.iasb.org).

David Morris is Chairman of FEI's Global Oversight Committee (GOC) and owner of Morris Consulting ([e-mail]). Morris represents FEI at the Intergovernmental Working Group of Experts on International Standards of Accounting and Reporting (ISAR) of the United Nations Conference on Trade and Development (UNCTAD).