Submission To IASB

Submission To IASB

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Submission to IASB

EXPOSURE DRAFT ON INTERNATIONAL FINANCIAL REPORTING STANDARD FOR SMALL AND MEDIUM-SIZED ENTITIES

International Accounting Standards Board
30 Cannon Street
LONDON EC4M 6XH
United Kingdom

Website: www.iasb.org

Dear Sir/Madam

EXPOSURE DRAFT ON INTERNATIONAL FINANCIAL REPORTING STANDARD FOR SMALL AND MEDIUM-SIZED ENTITIES

In response to your request for comments on the exposure draft on the International Financial Reporting Standard for Small and Medium-sized Entities (IFRS for SMEs), attached please find the comment letter prepared by the South African Institute of Chartered Accountants (SAICA).

We have consulted extensively on IFRS for SMEs. We issued an exposure draft requesting comments on our proposed process to early adopt IFRS for SMEs in its exposure draft form as a transitional standard for limited interest companies as defined in our Corporate Law Amendments Act. We held ten discussion forums with members in South Africa to elicit comments from them on the exposure draft. Two discussion forums were presented by Paul Pacter and the balance were presented by myself and Jacobus Badenhorst of Deloitte. Almost 1 000 members attended these sessions. Most of these members are preparers and auditors of SME type entities. Our conclusions incorporate the responses from this broad range of members.

This comment letter arises out of debates with SAICA's Accounting Practices Committee (the technical advisory body to the APB), SAICA's task force for SME reporting and the many preparers and auditors of small and medium-sized entities referred to above.

Please note that SAICA is not only a professional body, but is also secretariat for the Accounting Practices Board (APB), the official accounting standard setting body in South Africa.

We thank you for the opportunity to provide comments on this document. We have, in addition to our responses to the questions raised, also included general comments on aspects not specifically dealt with in the questions.

Please do not hesitate to contact us should you wish to discuss any of our comments.

Yours sincerely

Sue Ludolph
Project Director – Accounting
cc: Moses Kgosana (Chairman of the Accounting Practices Board)
Prof Alex Watson (Chairperson of the Accounting Practices Committee)

GENERAL COMMENTS

SAICA is fully supportive of this exposure draft and would also like to take this opportunity to commend the International Accounting Standards Board (IASB) on the considerable amount of time invested in this project and also the significant progress made to date. We would also like to commend the Board on the widespread consultation, in the form of the public exposure process, roundtables and field testing, to ensure the views of all interested parties are considered. We urge the Board to continue with this project and to issue a final standard as soon as possible.

Aligning IFRS for SMEs to IFRS with the same conceptual framework will assist SMEs in converting to IFRS when or if needed. Development of a global reporting standard for SMEs will also enhance global comparability between these entities.

Although we are supportive of this initiative, we believe that some significant simplifications are needed, before the final standard is issued, to further reduce the reporting burden on SMEs.

The key matters we have raised in our response are:

• The scope of IFRS for SMEs should be more clearly defined, specifically around the concept of public accountability.
• Our view that IFRS for SMEs should be a stand-alone document and the related implications on cross-references to IFRS.
• Our concern about the adoption of principles in IFRS for SMEs before they have been subject to due process in IFRS.
• Some of the requirements in the proposed IFRS for SMEs are too onerous for SMEs given the level of accounting knowledge of preparers and the needs of the users of the financial statements. This may result in lower quality financial statements when such onerous requirements are not fully complied with. Furthermore, the cost of compliance with such requirements is likely to outweigh the benefits derived from compliance with them. We therefore propose further recognition and measurement simplifications in respect of property, plant and equipment, consolidated financial statements, financial assets and financial liabilities, business combinations and goodwill, agriculture, investments in associates and joint ventures, leases, the income statement, discontinued operations and assets held for sale and intangible assets other than goodwill. See details in our response to Question 2 and Question 3.
• A wider application of an "undue cost or effort" principle to simplify accounting requirements further, is required.

The name of the document

It is questionable whether "IFRS for Small and Medium-sized Entities" is the appropriate name for this exposure draft. In South Africa (and, we suspect, in many other jurisdictions), the term SME is used as a general term to refer to smaller type entities. Section 1 of this exposure draft defines a SME, for which this exposure draft will be appropriate, by reference to the terms public accountability and general purpose financial statements. The population of entities included in the IFRS for SMEs definition is significantly larger than the population of entities which are generally described as SMEs. Because we support the application of the IFRS for SMEs to this larger population, we propose that an appropriate name for the standard is "IFRS for entities without public accountability".

Public accountability

We are of the view that more guidance should be provided around the concept of public accountability.

BC38 articulates the principle that the nature of the users of financial statements, rather than the nature of the business activity, should determine whether IFRS for SMEs or full IFRSs should be applicable. This principle is fundamental to the scope of IFRS for SMEs and should be included in the standard itself.

BC50 concludes that legislators and regulators of a country have the ability to mandate (within the scope of the standard itself) which entities should be required, permitted or prohibited to use IFRS for SMEs. This principle is fundamental to the scope of IFRS for SMEs and should be included in the standard itself.

Paragraph 1.2(a) states: "An entity has public accountability if it files, or it is in the process of filing, its financial statements with a securities commission or other regulatory organisation for the purpose of issuing any class of instruments in a public market".

• The term "file" is not commonly used in all jurisdictions. In South Africa, for example, an entity listed on the JSE Limited (JSE) does not file its financial statements with the JSE, but is required to submit them to the JSE. We suggest that this requirement be clarified by stating that an entity is publicly accountable if any security (debt or equity) is traded in a public market.

• The definition of public accountability in the glossary is not the same as the definition contained in paragraph 1.2. These two definitions should be identical.

• Paragraph 1.2(a) only refers to "for the purpose of issuing". Although it is clear that the intent of IFRS for SMEs is to include within the definition of entities with public accountability both those that have issued debt or equity securities in the past and those presently issuing debt or equity securities in the public market, the wording of the paragraph may be read to exclude entities that have previously issued debt or equity securities in a public market. This issue may also create confusion when the standard is translated into other languages.

• In some cases an entity listed on a stock exchange may acquire or dispose of an entity which complies with IFRS for SMEs. The JSE listing requirements require that the listed company prepares a circular or proxy information, including financial statements of the entity being acquired or disposed of. The question that arises is, where the entity being acquired or disposed of complies with IFRS for SMEs, may such financial statements be included in the circular given that the listed entity issuing the circular has public accountability, and still claim compliance with IFRS for SMEs? We note that this is not a matter for regulators only, because the question is whether the scope of IFRS for SMEs would permit this even if the regulator permitted it. Our interpretation of this is that the acquired or disposed entity now has public accountability because its financial statements are now being filed in relation to listed securities. Therefore the entity acquired or disposed should restate its annual financial statements to comply with full IFRS. Similar issues would arise where a jurisdiction requires the filing of guarantor financial statements and the guarantor is not otherwise publicly accountable.

Paragraph 1.2(b) states: "An entity has public accountability if it holds assets in a fiduciary capacity for a broad group of outsiders, such as a bank, insurance entity, securities broker/dealer, pension fund, mutual fund or investment banking entity".

We question the inclusion of a securities broker/dealer as an entity that holds assets in a fiduciary capacity, particularly because of the general principle in BC38 that the nature of the users should determine the applicability of full IFRS. A securities broker/dealer is unlikely to have a broad group of outside users for its financial statements because in most instances these financial statements will only be used for the purposes of the owners, taxation authorities and for regulatory requirements. The assets or liabilities which it holds as a broker are held as an agent and are therefore not included in the financial statements, while the assets and liabilities held as a dealer are ultimately for the account of the owners. The users are unlikely to rely on the annual financial statements of the stock broker/dealer for investment decisions and analysis of investments made as they can request additional information tailored for their needs.

Cost versus benefit

One of the qualitative characteristics of financial information is the balance between benefit and cost i.e. the benefits derived from information should exceed the cost of providing it. Information provided to satisfy the needs of users is therefore subject to the constraint of cost versus benefit. For SMEs it is more likely that for a specific requirement the cost may exceed the benefit. We do therefore welcome the fact that additional exemptions are introduced in IFRS for SMEs based on 'impracticability' or 'undue cost or effort' grounds.

As mentioned, IFRS for SMEs currently provides certain exemptions based on different grounds, e.g. paragraph 38.9 provides some exemptions based on impracticability on transition to IFRS for SMEs and paragraph 35.1 provides for the use of the cost model for biological assets where there is undue cost or effort involved in determining the fair value. We believe that one principle for exemptions should be applied consistently throughout IFRS for SMEs. Impracticability, as defined, is still a significant threshold. Our preference is to provide for exemptions by applying a lower threshold, namely undue cost or effort. Guidance should also be provided as to what undue cost or effort means. As no guidance is currently provided as to what constitutes undue cost or effort, application of this principle may give rise to divergent interpretations. In particular, there is a risk that it will not interpreted as a lower threshold than impracticability, which would appear to defeat the Board's specific intention in using this terminology in the agriculture section.

Wherever fair value measurement is required by IFRS for SMEs, we believe an undue cost or effort exemption should be provided, similar to the agriculture section, to allow a SME to apply cost as a measurement basis where the determination of fair value requires undue cost or effort (e.g. financial instruments, other than derivatives). In many developing markets, specialists may not always be available to assist in fair value determination. Obtaining accurate fair values may in such cases be a fairly costly exercise.

We address some specific suggestions for an undue cost or effort exemption throughout the rest of our comment letter.

Adopting principles in IFRS for SMEs before full IFRS - Income Taxes, Government Grants and Equity

We are of the view that IFRS for SMEs should not include principles that have not yet been through the full due process for inclusion in IFRS, as is currently the case for income taxes, government grants and equity. Amendments to IFRS for SMEs should therefore be as a result of amendments to IFRS and not the other way around. This view is further supported by BC69 where it is stated that existing IFRS excluding proposals on which the Board's due process is not yet completed, were the starting point for developing IFRS for SMEs. Introducing principles in IFRS for SMEs before they are introduced in IFRS gives rise to new terminology and principles, not previously known to users and preparers. We are not opposed to a SME having a different accounting treatment to an IFRS reporter. However where the section in IFRS for SMEs is based on an underlying IFRS with some amendments, we believe that the principles should be aligned to the current effective IFRS.

SPECIFIC COMMENTS ON QUESTIONS RAISED

Question 1

Stand-alone document

In deciding on the content of the proposed IFRS for SMEs, the IASB focused on the types of transactions and other events and conditions typically encountered by SMEs with about 50 employees. For such entities, the proposed IFRS is intended to be a stand-alone document, with minimal cross-references to full IFRSs.

With the objective of a stand-alone document in mind, are there additional transactions, other events or conditions that should be covered in the proposed standard to make it more self-contained? Conversely, is there guidance in the draft standard that should be removed because it is unlikely to be relevant to typical SMEs with about 50 employees?
We agree that IFRS for SMEs should be a stand-alone document, with minimal references to IFRS. To satisfy the objective of a stand-alone document, some cross-references to full IFRS should be removed from IFRS for SMEs and the relevant text should be included. In particular, as explained later, the full text of the fair value model in IAS 41 – Agriculture, should be included in IFRS for SMEs. .

The need for a stand-alone document, with minimal references to full IFRS, is also highlighted by the proposed maintenance of IFRS for SMEs. Whenever amendments are made to IFRS standards, there may be a need to revise any cross-references to full IRFS as they may become incorrect. Too many cross-references to full IFRS may therefore result in the need to revise these on a more regular basis than every two years.

Question 2

Recognition and measurement simplifications that the Board adopted

The draft IFRS for SMEs was developed by:
(a) extracting the fundamental concepts from the IASB Framework and the principles and related mandatory guidance from full IFRSs (including Interpretations), and
(b) considering the modifications that are appropriate in the light of users' needs and cost-benefit considerations.

Paragraphs BC70 – BC93 of the Basis for Conclusions describe the simplifications of recognition and measurement principles contained in full IFRSs that have been made in the proposed IFRS for SMEs and explain the Board's reasoning.

Are there other recognition or measurement simplifications that the Board should consider? In responding, please indicate:
(a) the specific transactions, other events or conditions that create a specific recognition or measurement problem for SMEs under IFRSs;
(b) why it is a problem; and
(c) how that problem might be solved.

We support the recognition and measurement simplifications proposed by the Board. We would propose the following further simplifications for the reasons described next to each proposal.

Question 3

Recognition and measurement simplifications that the Board considered but did not adopt

Paragraphs BC94 – BC107 identify some recognition and measurement simplifications that the Board considered but decided not to adopt, for the reasons noted.
Should the Board reconsider any of those and, if so, why?

We agree with the Board's conclusions in respect of all the rejected simplifications except for the requirement to prepare consolidated financial statements. We also comment on the cost model for agriculture.

Consolidated financial statements

In many jurisdictions the legal framework provides requirements as to when an entity should prepare consolidated financial statements. Depending on the needs of users in a specific jurisdiction, the cost incurred as a result of the requirement to prepare consolidated financial statements may exceed the related benefit. Risk assessment procedures differ between various jurisdictions e.g. in some jurisdictions banks and tax authorities look at the consolidated annual financial statements whereas in other jurisdictions this is not the case. In South Africa it was established through the discussion forums that the main users of financial statements of SMEs tend to look at the separate financial statements of the legal entities in the group and therefore do not use consolidated financial statements. Furthermore, most SMEs also do not have adequately skilled staff to prepare the consolidated financial statements.

BC104 indicated that in certain instances two or more legal entities operate as a single economic entity and that the users of the financial statements require consolidated annual financial statements in order for them to make a meaningful assessment of the financial position, cash flows and the results of the economic entity. We support this view. However further guidance should be provided as to when different legal entities should be viewed as a single economic entity. IFRS 8 – Operating Segements, contains, as one of its criteria to identify an operating segment, that the operating results of that component of the entity be reviewed regularly by the entity's chief operating decision maker to make decisions about resources to be allocated to the segment and to assess its performance. The way in which management views and manages the business therefore plays a role in identifying operating segments. We propose that the principles in IFRS 8 be adapted on how to identify whether operations in the various legal entities represent different economic entities. For example, in a group with diverse operations, a treasury function in a separate legal entity may not be viewed as part of a separate economic entity whereas a group having one legal entity for its operations and one legal entity for its buildings may be viewed as a single economic entity. Where the legal entities are not operating as a single economic entity, we believe that the requirements to prepare consolidated financial statements should be made optional in IFRS for SMEs.

Where an entity does not prepare consolidated financial statements, related party disclosure becomes a very important part of the financial statement disclosure. Separate legal entities may enter into transactions with each other that may not necessarily be structured on an arm's length basis. In circumstances of non-consolidation, preparers should be reminded of the related party disclosure requirements in Section 33.

Where consolidated financial statements are not prepared, the investment in the subsidiary should be accounted for in accordance with Section 11 - Financial Assets and Financial Liabilities. Where the instrument is publicly traded in an active market, it should be carried at fair value and where it is not publicly traded and its fair value cannot be measured without undue cost or effort, it should be carried at cost.

In the separate financial statements, an investment in a subsidiary should be accounted for in accordance with Section 11. Also refer to the simplifications proposed for investments in associates and joint ventures in question 2.

Agriculture

Fair value measurement

IAS 41 – Agriculture, requires that biological assets be measured at fair value unless, upon initial recognition, market-determined prices are not available and alternative estimates of fair value are determined to be clearly unreliable. IFRS for SMEs requires that an entity applies the fair value model to account for biological assets whose fair value is readily determinable without undue cost or effort. We have established through our discussion forums that for some biological assets fair values will be readily determinable, for example, livestock. We expect that the fair value model will be used extensively for these items and therefore the cross-reference to IAS 41 should be eliminated and the relevant text from IAS 41 should be included in IFRS for SMEs.

Applying the cost model

We are of the view that this section should include a clear statement that the ‘undue cost and effort' requirement in IFRS for SMEs, to apply the cost model, represents a significantly lower hurdle (when compared to IAS 41). This appears to be the intention of the board, but we are concerned that in the absence of an explicit statement to this effect, undue cost or effort will be equated with the reliable measurement criterion of IAS 41.

Given the significantly lower hurdle to account for biological assets at cost and the responses obtained from the discussion forums, it is expected that the cost model will be widely applied by SMEs in South Africa. We are however of the view that the section on agriculture contains inadequate guidance on applying the cost model. Guidance on applying the cost model should be expanded as the cost model is expected to be applied more often in a SME environment. Furthermore, a paragraph similar to IAS 41 paragraph 33, where cross-references are made to other sections in IFRS for SMEs dealing with the cost model, should be inserted.

Question 4

Whether all accounting policy options in full IFRSs should be available to SMEs

The draft IFRS for SMEs proposes that accounting policy options available under full IFRSs should generally also be available to SMEs. As explained more fully in paragraphs BC108 – BC115 of the Basis for Conclusions, the Board concluded that prohibiting SMEs from using an accounting policy option that is available to entities using full IFRSs could hinder comparability between SMEs and entities following full IFRSs. At the same time, the Board recognised that most SMEs are likely to prefer the simpler option in the proposed IFRS for SMEs. Therefore, the Board concluded that in six circumstances in which full IFRSs allow accounting policy options, the IFRS for SMEs should include only the simpler option, and the other (more complex) option(s) should be available to SMEs by cross-reference to the full IFRSs.

Do you agree with the Board's conclusions on which options are the most appropriate for SMEs? If not, which one(s) would you change, and why?

Should any of these options that would be available to SMEs by cross-reference to the full IFRSs be eliminated from the draft IFRS for SMEs and, if so, why?

We agree with the accounting policy options currently proposed in IFRS for SMEs.

As discussed in Question 1, we prefer the IFRS for SMEs to be a stand-alone document. To achieve this objective, where accounting policy options are available, the text of both options should be included in IFRS for SMEs. For the text of the option currently contained in full IFRS, it should be considered whether any simplifications can be made when incorporating the text in IFRS for SMEs. Currently a SME electing to apply one of the cross-references to full IFRS is disadvantaged by being required to comply with all the full IFRS requirements and disclosures for that section.

Question 5

Borrowing costs

IAS 23 Borrowing Costs currently allows entities to choose either the expense model or the capitalisation model to account for all of their borrowing costs. In May 2006 the IASB published an Exposure Draft proposing to amend IAS 23 to prohibit the expense model and to require the capitalisation model. Section 24 Borrowing Costs of the draft IFRS for SMEs proposes to allow SMEs to choose either the expense model or the capitalisation model.

Do you agree or disagree with the proposal to allow SMEs to choose either the expense model or the capitalisation model for borrowing costs, and why?

We support this proposal. There are other sections in IFRS for SMEs where the accounting requirements are also different to current IFRS for example the accounting for financial instruments. Some of the overriding considerations in developing IFRS for SMEs were the needs of the users and cost versus benefit. Based on these considerations, we are of the opinion that in certain areas it is justified to introduce different accounting requirements, when compared to full IFRS, in IFRS for SMEs. Different accounting treatments are acceptable as long as they can be justified in terms of the Conceptual Framework of IFRS for SMEs which is similar to that of IFRS. We would however encourage the Board to explain the basis for its conclusion that for full IFRS reporters capitalisation is the required option, but for SMEs expensing of borrowing costs is allowed.

Question 6

Topics not addressed in the proposed IFRS for SMEs

Some topics addressed in full IFRSs are omitted from the draft IFRS for SMEs because the Board believes that typical SMEs are not likely to encounter such transactions or conditions. These are discussed in paragraphs BC57–BC65 of the Basis for Conclusions. By a cross-reference, the draft standard requires SMEs that have such transactions to follow the relevant full IFRS.

Should any additional topics be omitted from the IFRS for SMEs and replaced by a cross-reference? If so, which ones and why?

As discussed in Question 1, to achieve the objective of a stand-alone document, some cross-references to IFRS should be eliminated. It was established through our discussion forums that for many biological assets (e.g. livestock) a fair value is readily determinable in which case the references to IAS 41 paragraphs 10 − 29 should be applied. Based on this, we are of the view that the text of full IFRS around the fair value model, with simplification where needed, be included for agriculture and the cross-reference be eliminated.

In our view, no additional topics should be removed from IFRS for SMEs and be incorporated by means of a cross-reference to full IFRS.

Question 7

General referral to full IFRSs

As noted in Question 1, the IFRS for SMEs is intended to be a stand-alone document for typical SMEs. It contains cross-references to particular full IFRSs in specific circumstances, including the accounting policy options referred to in Question 4 and the omitted topics referred to in Question 6. For other transactions, events or conditions not specifically addressed in the IFRS for SMEs, paragraphs 10.2–10.4 propose requirements for how the management of SMEs should decide on the appropriate accounting. Under those paragraphs, it is not mandatory for SMEs to look to full IFRSs for guidance.

Are the requirements in paragraphs 10.2 – 10.4, coupled with the explicit cross-references to particular IFRSs in specific circumstances, appropriate? Why or why not?

We welcome the fact that there is no mandatory fallback to full IFRS when a SME needs to develop an accounting policy, in terms of Section 10, for a transaction not dealt with in IFRS for SMEs. The fact that there is no mandatory fallback to IFRS makes it even more important to ensure that adequate guidance, for each possible transaction a SME may enter into, is included in IFRS for SMEs. Refer to our responses to questions 4, 6 and 8.

Since IFRS and IFRS for SMEs are based on a similar conceptual framework, it may be difficult to argue an accounting policy different to full IFRS is appropriate where IFRS for SMEs contains no guidance for that type of transaction. In the current environment auditors are exposed to more scrutiny, a more stringent regulatory environment and the increased potential risk of public liability. Due to these pressures faced by auditors, in order to minimise risk, they may effectively force compliance with full IFRS, for transactions not dealt with in IFRS for SMEs, in terms of the hierarchy in Section 10. Therefore we believe that IFRS for SMEs should include a very clear statement that the application of IFRS and the related interpretations is never required for SMEs.

Question 8

Adequacy of guidance

The draft IFRS for SMEs is accompanied by some implementation guidance, most notably a complete set of illustrative financial statements and a disclosure checklist. A sizeable amount of guidance that is in full IFRSs is not included. Accordingly, additional guidance especially tailored to the needs of SMEs applying the proposed IFRS may be required.

Are there specific areas for which SMEs are likely to need additional guidance? What are they, and why?

We believe that the accompanying implementation guidance will be a very useful tool to successfully implement IFRS for SMEs. To make IFRS for SMEs a truly stand-alone and useful tool, we believe that additional guidance is needed in certain areas:

Illustrative financial statements and disclosure checklist

Where requirements of IFRS for SMEs are no different to requirements of IFRS, the layout and format of the illustrative financial statements should be consistent to that in IAS 1– Presentation of Financial Statements. For example, in the illustrative financial statements to IAS 1, non-current assets are listed before current assets whereas in the illustrative financial statements to IFRS for SMEs the sequence is the other way around. Such differences may lead users/preparers to believe there are differences in requirements where it is not the case. This was established through our discussion forums.

We are aware of some differences between the disclosure requirements in a specific section when compared to the disclosure checklist and the illustrative financial statements. For example, note 12 on deferred tax in the illustrative financial statements gives a detailed reconciliation of the deferred tax liabilities (assets) for software and long-service benefit. This disclosure is required by IAS 12 − Income Taxes, paragraph 81(g). No similar disclosure requirements are contained in IFRS for SMEs. It may therefore be necessary to carefully compare the disclosure requirements between all documents as such differences may be confusing to users/preparers as to what the real disclosure requirements are.

Interpretations of IFRS

The proposed IFRS for SMEs currently includes very little of the guidance contained in the IFRIC and SIC interpretations. We believe that the Board should carefully assess the need to include text of some of the interpretations in IFRS for SMEs as some interpretations expand on principles contained in IFRS for SMEs. For some interpretations the text of the interpretation has become an integral part of the requirements in the related IFRS. We believe that text relating to the following IFRIC and SIC interpretations should be included in IFRS for SMEs:

IFRIC Interpretations

• IFRIC 1− Changes in existing decommissioning, restoration and similar liabilities
• IFRIC 4− Determining whether an arrangement contains a lease
• IFRIC 8− Scope of IFRS 2
• IFRIC 12− Service concession arrangements

SIC Interpretations

• SIC 12 – Consolidation : Special purpose entities
• SIC 15 − Operating leases : Incentives
• SIC 29 − Service Concession arrangements : Disclosures

Additional guidance to be included in various sections

Scope paragraphs – individual sections
We are of the opinion that the individual sections of IFRS for SMEs should include similar scope exclusions as the relevant full IFRS unless the scope exclusion will not apply, because the topic is not dealt with in IFRS for SMEs or the IFRS for SMEs principles are different to full IFRS. We have therefore not commented in detail on each scope section, but we do include some examples to substantiate this comment. We suggest that where the Board amends an IFRS scope paragraph in IFRS for SMEs, the rationale behind such amendment should be explained in the basis for conclusions.

Examples of some amendments needed to scope paragraphs in IFRS for SMEs include:

• IAS 39 – Financial Instruments: Recognition and Measurement, scopes out, from the perspective of the acquirer, contracts for contingent consideration in a business combination as it is dealt with in IFRS 3 – Business Combinations. Section 11 does not contain a similar scope exclusion despite the fact that Section 18 on business combinations deals with contingent consideration.
• IAS 2 – Inventories, contains some general scope exclusions and then some further scope exclusions only around the measurement of inventories. Section 12 only contains some scope exclusions around the measurement of some inventories. The general scope exclusions in IAS 2 paragraph 2 are however likely to apply in IFRS for SMEs as all the exclusions listed in IAS 2 paragraph 2 are also dealt with separately in IFRS for SMEs.
• Section 16 on property, plant and equipment currently does not contain any scope exclusions. However, the scope exclusions in IAS 16 – Property, Plant and Equipment, paragraph 3(a), (b) and (d), with some amendments where necessary, are likely to apply in IFRS for SMEs.
• Section 18 on business combinations currently only scopes out common control business combinations. The other scope exclusions, as contained in IFRS 3 paragraph 3, may however also arise in applying IFRS for SMEs and should therefore be dealt with.
• Section 25 on share-based payment does not contain any scope paragraphs. IFRS 2 - Share-based Payment,does however contain scope exclusions. It is important to state, for example, that share-based payment transactions within the scope of Section 11 onFinancial Assets and Financial Liabilities are scoped out of Section 25. This comment is also applicable to the scope paragraph of Section 11.

Section 7 – Cash Flow Statement
We believe the following guidance from IAS 7 – Cash Flow Statements, should be included in IFRS for SMEs:

• when cash flows may be reported on a net basis (SMEs tend to do net reporting on an inappropriate basis);
• allowing an entity to use an exchange rate that approximates the actual exchange rate for foreign currency cash flows;
• investments in subsidiaries, associates and joint ventures; and
• acquisitions and disposals of subsidiaries and other business units.

Section 9 – Consolidated and Separate Financial Statements
This section currently gives guidance on how to allocate the profit or loss when potential voting rights exist and consolidated financial statements are prepared. If consolidated financial statements are required, guidance should also be inserted, similar to IAS 27 – Consolidated and Separate Financial Statements, paragraphs .14 and 15, to assess when potential voting rights give rise to control.

Section 10 – Accounting Policies, Estimates and Errors
IFRS for SMEs requires retrospective application of a change in accounting policy. IFRS for SMEs only deals with a situation where it is impracticable to determine the individual period effects of changing an accounting policy. It does not deal with the situation where it is impracticable to determine the cumulative effect at the beginning of the current period of changing an accounting policy. Some SMEs may encounter such a situation when changing an accounting policy. Consequently, we suggest inclusion of IAS 8 – Accounting Policies, Changes in Accounting Estimates and Errors, paragraph 25.

Section 11 – Financial Assets and Financial Liabilities
Section 11 does not contain any guidance on initial measurement of financial assets and financial liabilities. Consideration should be given to insert guidance similar to IAS 39– Financial Instruments: Recognition and Measurement, paragraphs 43 and 44.

Section 11 does not contain any guidance on offsetting of a financial asset and liability. We propose that guidance similar to IAS 32 – Financial Instruments: Presentation, paragraph 32 – 50 be included.

Section 15 – Investment Property
Classifying a property as an investment property or not may require significant judgement and is in many cases a complex area. It is therefore questionable whether SMEs would be able to perform such classification by merely referring to the definition of an investment property in paragraph 15.1. We are therefore of the opinion that the guidance in IAS 40 – Investment Property, paragraphs 7 – 15 should be included, with amendments where necessary. Including the guidance would assist SMEs in dealing with owner-occupied buildings, buildings where only a portion qualifies as investment property. This matter was raised as a concern at numerous discussion forums.

Paragraph 15.5 indicates that when an entity uses the fair value model to account for investment property, reference should only be made to IAS 40 paragraphs 33 – 55 relating to measurement and paragraphs 75 – 78 relating to disclosure. As IFRS for SMEs does not give any further guidance around the fair value model, additional guidance from IAS 40 may be required. It should therefore be clarified that other paragraphs (e.g. transfers and disposals) of IAS 40 will also apply to the fair value model.

Section 16 – Property, Plant and Equipment
Paragraph 16.10 makes reference to the term “lacks commercial substance” without providing any additional guidance as how to interpret this term. Guidance similar to that in IAS 16 paragraph 25 should be inserted to assist SMEs to interpret this term.
For entities electing to apply the revaluation model, it should be made sufficiently clear that such an entity needs to comply with the relevant paragraphs in IAS 16 as well as all the other requirements of Section 16 in IFRS for SMEs.

Section 17 – Intangible Assets other than Goodwill
Paragraph 17.11 makes reference to the term “lacks commercial substance” without providing any additional guidance as how to interpret this term. Guidance similar to that in IAS 38 − Intangible Assets, paragraph 46 should be inserted to assist SMEs to interpret this term.

For entities electing to apply the revaluation model, it should be made sufficiently clear that such an entity needs to comply with the relevant paragraphs in IAS 38 as well as all the other requirements of Section 17 in IFRS for SMEs.

Section 18 – Business Combinations and Goodwill
Given that this section requires the purchase method to be applied in accounting for business combinations, we are of the opinion that additional guidance is needed to determine the fair values of assets and liabilities acquired. Consideration should therefore be given to including paragraphs B16 and B17 from IFRS 3, Appendix B.

Further additional guidance from IFRS 3 that should, in our view, be included is:

• Currently only the mandatory guidance in IFRS 3 around determination of the cost of a business combination has been included in IFRS for SMEs. Without the additional guidance contained in IFRS 3, entities may find it difficult to account appropriately for deferred settlement terms and the fair value of equity instruments granted. We therefore suggest including guidance around these topics.
• We are of the opinion that guidance on accounting for business combinations achieved in stages should be include in IFRS for SMEs. Under IFRS there are potential different interpretations on how to account for these transactions. Without any guidance in IFRS for SMEs, it may lead to even more divergent practices.
• It is very likely that SMEs enter into business combination transactions where profit warranties are, for example, part of the agreement. It is therefore necessary to include guidance, similar to IFRS 3 paragraphs 61 – 65, where the initial accounting for the business combination was provisionally determined. Consideration should also be given to simplify the requirements to allow the adjustments being made on a prospective basis and where comparative information is therefore not restated.

Section 19 – Leases
Paragraph 19.11, for depreciation by a lessee of a leased asset in terms of a finance lease, only refers to Section 16 on Property, Plant and Equipment. The leased asset may however also be an intangible asset. Therefore a reference to Section 17 onIntangible Assets other than Goodwillshould therefore be inserted. This Section should also include a reference to Section 26 on Impairment of Non-financial Assetsto determine whether a leased asset is impaired.

Section 21 – Equity
With regards to treasury shares, it should be clarified, similar to IAS 32 paragraph 33, that in some cases treasury shares may be acquired and held by other members of the consolidated group.
Please also refer to the general comment made in the introduction to this letter around adopting new principles in IFRS for SMEs before adopted in full IFRS. Paragraph 21.11 states the following:

“In consolidated financial statements, a minority interest (i.e. non-controlling interest) in the net assets of a subsidiary is included in equity. An entity shall treat changes in a parent's controlling interest in a subsidiary that do not result in a loss of control as transactions with equity holders in their capacity as equity holders. An entity shall not recognise gain or loss on these changes in consolidated profit or loss. Also, an entity shall not recognise any change in the carrying amounts of assets (including goodwill) or liabilities as a result of such transactions.”

The last paragraph of this section is not adequately explained. Does this imply that in such cases no fair value adjustments are made to the assets and liabilities?

Section 22 – Revenue
The appendix from IAS 18− Revenue, was included as an appendix to Section 22 in IFRS for SMEs. Issues were experienced previously with the application of the appendix in full IFRS, more specifically, example 19 relating to recognition of revenue from services. We are of the opinion that this example should be removed from the appendix to Section 22 as this may cause confusion and create concerns about the reliability of the appendix. The removal of this example from the appendix may however raise questions regarding the status of this example in full IFRS.

Construction contracts that SMEs are likely to enter into are not necessarily different to those that entities with public accountability will enter into. Therefore, given that the principles in IFRS for SMEs are very similar toIAS 11 – Construction Contracts, we suggest that the following guidance from IAS 11be included, with simplifications where needed:

• SMEs are likely to enter into fixed price contracts as well as cost-plus contracts. Therefore, we suggest that these terms be defined in IFRS for SMEs. IAS 11 paragraph 23 and IAS 11 paragraph 24 give guidance as to when the outcome of a fixed price contract and a cost-plus contract can be estimated reliably. We believe that these requirements may be easier for SMEs to apply and interpret than the current reference in paragraph 22.17 to reliable estimates of the stage of completion, future costs and collectibility of billings. Separate guidance for fixed price contracts and cost-plus contracts (similar to IAS 11) should therefore be included in IFRS for SMEs.

Paragraph 22.31 requires disclosure of the gross amount due from customers and gross amount due to customers for contract work. No guidance is given as to how these amounts should be calculated and users may therefore find it difficult to apply. We suggest that guidance similar to IAS 11 paragraphs 43 and 44 be included in IFRS for SMEs.

Section 23 – Government grants
Accounting for government grants is not just an issue experienced by SMEs. Companies complying with IFRS experience difficulty in applying IAS 20 – Accounting for Government Grants and Disclosure of Government Assistance. We would therefore encourage the Board to first review the principles in IAS 20. It is questionable whether IFRS for SMEs should change requirements in full IFRS, where it is not really a simplification, but rather a change as a result of issues experienced with the full IFRS.

Section 26 – Impairment of non-financial assets
Where an impairment loss for a “smallest identifiable group of assets” is identified, no guidance is provided as to how such impairment loss should be allocated to the individual assets in that group. Similarly, where there is a reversal of an impairment loss for a "smallest identifiable group of assets", no guidance is given as to how the reversal should be allocated to the individual assets in such a group. Such guidance should be provided.

Where an impairment loss is allocated to individual assets in a "smallest identifiable group of assets", IFRS for SMEs does not give any guidance as to the limit on the impairment loss to be allocated to each individual asset. Such guidance should be provided.

Paragraph 26.12 requires that an entity recognises an impairment loss immediately in profit or loss. Other sections of IFRS for SMEs do however permit the use of a revaluation model, for example property, plant and equipment and intangible assets. Paragraph 26.12 should state that an impairment loss of a revalued asset should be treated as a revaluation decrease. This would be consistent with the guidance in paragraph 26.18 where a reversal of an impairment loss for a revalued asset is treated as a revaluation increase.

Section 28 – Income Taxes
We support the view that a SME should account for deferred tax. The responses obtained from the discussion forums held indicated that entities in South Africa, currently applying IFRS, are used to the temporary difference approach and are resistant to changing the method in providing for deferred tax.

We do however acknowledge that when an entity previously reported under national GAAP, using a different approach from temporary differences in IFRS, it may be very onerous to apply the temporary difference approach. We can therefore see an argument for both of the abovementioned views.

We are of the opinion that the current IAS 12 – Income Taxes requirements for providing deferred tax should be included in IFRS for SMEs as there are certain areas in the current version of the income taxes section of IFRS for SMEs that require further clarification for example:

• Section 28 does not give any guidance as to when current tax liabilities and current tax assets and deferred tax liabilities and deferred tax assets may be offset. As SMEs may face this question, we suggest guidance from IAS 12 paragraphs 71 – 76 is included and simplified where needed.
• For the points mentioned below please also refer to the general comment made in the introduction to this letter around adopting new principles in IFRS for SMEs before adopted in full IFRS.

• Paragraph 28.3 makes reference to the tax basis of an asset, liability or an equity instrument. It is not clear why an equity instrument is included here as IAS 12only refers to the tax basis of an asset or a liability. Additional guidance should be provided as to why the definition in IFRS for SMEs is wider.
• We suggest that the heading before paragraph 28.11 be changed to ‘Investments in subsidiaries, associates and joint ventures'. Paragraph (a) should then clarify that such differences will arise whenever consolidation or proportionate consolidation is applied. Paragraph (b) should clarify that these differences may arise in the investor's separate financial statements as well as in the consolidated financial statements when the equity method is applied. The current heading to paragraph 28.11 creates the idea that the differences only arise in the consolidated financial statements, which is not necessarily the case.
• Additional guidance is required in order to understand and to apply the requirements of paragraph 28.17. The current wording of the paragraph makes it extremely difficult to understand and to apply the requirements of this paragraph.

Section 38 – Transition to IFRS for SMEs
Although we welcome the relief granted in terms of deferred tax on initial adoption of IFRS for SMEs, we believe that further guidance should be given around this matter. Currently it is not clear what the situation around provision of deferred tax for assets and liabilities where this exemption has been taken will be, once the entity has adopted IFRS for SMEs.
Also refer to question 10 for further comments on transition guidance.

Question 9

Adequacy of disclosures

Each section of the draft IFRS for SMEs includes disclosure requirements. Those requirements are summarised in the disclosure checklist that is part of the draft implementation guidance Illustrative Financial Statements and Disclosure Checklist.

Are there disclosures that are not proposed that the Board should require for SMEs? If so, which ones and why? Conversely, do you believe that any of the proposed disclosures should not be required for SMEs? If so, which ones and why?

We are pleased to note a significant decrease in the disclosure requirements when compared to full IFRS. This will certainly assist in reducing the volume of the annual financial statements of a SME. From a cost-benefit point of view, we do however believe that IFRS for SMEs does not go far enough to simplify disclosure requirements.

As highlighted in questions 4 and 6, where text of options currently cross-referenced to full IFRS is included in IFRS for SMEs, there is also a very strong argument to require simplified disclosures for these sections if included in IFRS for SMEs.

In general, we believe that disclosures should be limited to information that is material to an understanding of a typical SMEs financial statements. Although we acknowledge that having a disclosure checklist is useful, we are concerned that certain of the disclosure requirements are excessive. We also believe that the Board should state specifically that non-material items will not require disclosure.

On the basis that a SME does not have public accountability, and taking into account the cost of compliance versus the benefits of disclosure, we recommend that the following presentation requirements and / or disclosures be deleted from the IFRS for SMEs:

18.23(h) description of the factors giving rise to goodwill or any excess recognised in profit or loss;
18.23(i) acquiree's profit since the acquisition date;
20.14(h) expected reimbursements;
20.16 contingent assets;
26.26 split by class;
30.26 foreign currency translation differences;
33.4 ultimate controlling party;
33.5-6 key management personnel compensation; and
35.1(b) fair value information about biological assets measured using the cost model (ii)-(iii).
We believe that the following disclosures in paragraph 5.7 are duplicated and therefore should be deleted:
(a) which is required by paragraph 26.25;
(b) which is required by paragraph 12.21;
(c) which is required by paragraph 20.14;
(f) which is required by paragraph 36.2; and
(h) which is required by paragraph 20.14.
In respect of the statement of cash flows:

• Paragraph 7.10 requires acquisitions and disposals of subsidiaries and other business units to be presented as operating activities. We assume that this paragraph should refer to investing activities.
• We believe that paragraph 7.17 should include a simple requirement to present cash flows related to income taxes as operating cash flows. We believe that raising the possibility of allocating cash flows to different activities is an unnecessary complication for SMEs.

It is not clear to us why certain 'other disclosures' included in paragraph 8.4(d) are not addressed in their respective sections. Paragraph 8.4 deals with the order in which notes will be presented and part (d) considers other disclosures of which three are not addressed elsewhere in the IFRS for SMEs. We recommend removing the examples in 8.4(d)(i), (ii), (iii) and (iv) and leaving the header of 8.4(d) ‘other disclosures'. All other disclosures currently addressed in 8.4(d)(ii), (iii) and (iv) could be included in their respective sections so that a SME will only need to refer to the relevant section to ensure that it has properly captured the required accounting and relevant disclosure requirements.

In respect of combined financial statements in Section 9, we believe that a SME should be required to disclose:

• the basis for determining which entities are included in the combined financial statements.
• the basis of preparation of the combined financial statements; and

In respect of the reconciliation of movements in the balance of classes of property, plant and equipment (paragraph 16.29(e)), we recommend having additions as a single item, rather than separating it from acquisitions through business combinations. This would be consistent with paragraph 17.32(e) in respect of intangible assets.

In respect of intangible assets acquired by way of government grant, we believe that the disclosures required by paragraph 17.33(c) are unnecessary in addition to the disclosures required by paragraph 23.5.

We believe that the IFRS for SMEs should be consistent with the forthcoming amendments to IAS 24 − Related Party Disclosures, assuming that the revised IAS 24 is issued prior to the IFRS for SMEs.

In respect of revenue in Section 22, we believe that amounts recognised by virtue of the SME acting as an agent should be disclosed separately.

The disclosure in paragraph 27.38(g) is not included in IAS 19 and we believe that it is unnecessary.
The following comments were also received at some of the discussion forums:

Section 19 on Leasesrequires that an entity discloses the total of future minimum lease payments for each future year. This requirement is vaguer and could potentially be more onerous than the requirement in IAS 17 – Leases to split minimum lease payments between, not later than one year, later than one year and not later than five years and later than five years. To give clearer guidance in IFRS for SMEs and simplify the requirement, it should be required that minimum lease payments be split between current and non-current.

IAS 12 requires an explanation of the relationship between the tax expense (income) and accounting profit as either:

• A numerical reconciliation between tax expense (income) and the product of accounting profit multiplied by the applicable tax rate, or
• A numerical reconciliation between the average effective tax rate and the applicable tax rate.

Paragraph 28.29 (b) of IFRS for SMEs only allows the first option listed above. Some users or preparers may find it more useful and easier to understand when the reconciliation is prepared in terms of percentages. We propose therefore that both options be allowed in IFRS for SMEs.

Question 10 – Transition guidance

Section 38 Transition to the IFRS for SMEs provides transition guidance for SMEs that move (a) from national GAAP to the IFRS for SMEs and (b) from full IFRSs to the IFRS for SMEs.

Do you believe that the guidance is adequate? If not, how can it be improved?

This section is based mainly on the provisions of IFRS 1 – First-Time Adoption of International Financial Reporting Standards. We are of the view that the exemptions in Section 38 are too restrictive when compared to IFRS 1. We would therefore encourage the Board to consider inclusion of further IFRS 1 exemptions not currently dealt with in IFRS for SMEs, for example, assets and liabilities of subsidiaries, associates and joint ventures where consolidated financial statements are prepared (IFRS 1.24),etc.
It appears as if not all situations which can arise, as a result of simplifications made to IFRS for SMEs, on initial adoption have been contemplated. For example, the preferred method of measurement for investment property in IFRS for SMEs is the cost method. If an entity, under its previous financial reporting framework, carried its investment property at fair value, there may be instances where it is onerous to determine the original cost of the investment property. This concern was raised in various discussion forums. Paragraph 38.8 only provides an exemption for property, plant and equipment to use fair value or the revalued amount as deemed cost. We suggest that the scope of this exemption be widened to allow this exemption for any asset, measured at fair value or revalued amount, and where the preferred method of measuring the asset is cost in accordance with IFRS for SMEs.

Question 11

Maintenance of the IFRS for SMEs

The Board expects to publish an omnibus exposure draft of proposed amendments to the IFRS for SMEs approximately every other year. In developing such exposure drafts, the Board expects to consider new and amended IFRSs that have been adopted in the previous two years as well as specific issues that have been brought to its attention regarding possible amendments to the IFRS for SMEs. On occasion, the Board may identify a matter for which amendment of the IFRS for SMEs may need to be considered earlier than in the normal two-year cycle.

Is this approach to maintaining the proposed IFRS for SMEs appropriate, or should it be modified? If so, how and why?

We are supportive of this proposal. This will avoid SMEs having to change their accounting systems too often and will also allow time for adequate training of the relevant accounting staff. In terms of effective dates of these amendments, it would be important to allow enough time for SMEs to prepare for adoption of these amendments.

As discussed under question 1, we believe IFRS for SMEs should be as stand-alone as possible with minimal cross-references to IFRS. Whenever changes are made to IFRS, a need may arise to update the relevant cross-references. IFRS for SMEs should include specific guidance on how an entity should deal with a situation where IFRS for SMEs contains a cross-reference to IFRS and the related IFRS is amended. Too many cross-references to IFRS may result in revisions being required on a more frequent basis than every two years. It may also be necessary to include guidance in the accounting policy hierarchy in Section 10 to clarify which version of IFRS a SMEs should be referred to when it looks to full IFRS for guidance in developing an accounting policy. By ensuring all potential transactions entered into by a SME are adequately covered by IFRS for SMEs, this may eliminate our concern to a great extent.

On initial adoption of IFRS for SMEs consideration should be given to amend ‘fatal flaws' identified on a timelier basis. Initially, entities applying IFRS for SMEs, will likely identify areas where changes are needed. The Board should assess the significance of such required changes, and where significant, consider amending IFRS for SMEs earlier than after a two year period.

OTHER COMMENTS

Editorial edits

During our review of the exposure draft the following items, requiring editing in the final IFRS for SMEs, came to our attention. This is not intended to be a complete list of edits required, but merely highlights items identified during our review.

Section 5 – Income Statement
This section does not contain a paragraph 5.8. Consequently the paragraphs should be renumbered.

Section 7 – Cash Flow Statement
Paragraph 7.10 of IFRS for SMEs requires that cash flows arising from acquisitions and disposals of subsidiaries and other business units are classified as operating activities. We believe such cash flows, consistent with IAS 7, should be classified as investing activities.

Section 11 – Financial Assets and Financial Liabilities
The heading to paragraph 11.48 refers to “income statement and equity”. Does section does however seem to only refer to items recognised in profit or loss. It is therefore questionable whether the reference to “equity” is appropriate.

Section 17 – Intangible Assets other than Goodwill
The heading of paragraph 17.30 “Recoverability of the carrying amount – impairment losses” appears to be in the wrong format. Currently it appears to be a sub-heading of the section on intangible assets with indefinite useful lives. Paragraph 17.30 should however apply to intangible assets with finite useful lives as well as indefinite useful lives.

Section 21 – Equity
Paragraph 21.3 requires discounting where payment is deferred and the time value of money is significant. Paragraph 20.8 in Section 20 on Provisions and Contingenciesrequires discounting where the time value of money is material. From a consistency point of view, we suggest that all references, throughout IFRS for SMEs, be to where the time value of money is material.

Section 22 - Revenue
This section deals with the revenue recognition principles as contained in IAS 18. It also deals with the principles around construction contracts as contained in IAS 11. IAS 11 deals with more than just revenue recognition, as it also deals with the accounting treatment for some contract costs. To make it clearer as to what Section 22 deals with, we suggest that the name be changed to ‘Revenue and Construction Contracts'.
Section 28 - Income taxes
Paragraph 28.2 "deferred tax liabilities……."should be Deferred tax liabilities…
The last paragraph of paragraph 28.16 should be amended to explain clearly how a deferred tax asset arises, as this paragraph is included under the heading of deductible temporary differences. Consequently we propose that the paragraph be amended as follows:

"Such differences can arise in business combinations or on the initial acquisition of individual assets or liabilities. For example, a deferred tax asset or liability is recognised when the amount allocated to an asset acquired in a business combination is its fair value at the acquisition date, but the future tax-deductibility is limited by law to the acquired entity's original cost basis, which is higher than the fair value at acquisition date."

Alternatively, the whole of subparagraph (c) should be included as part of paragraph 28.17 as the initial recognition of an asset or a liability may give rise to either a taxable temporary difference or a deductible temporary difference and not only a deductible temporary difference, as the heading currently seems to imply.

Glossary
Hedged item – this definition should be aligned with paragraph 11.31. Currently paragraph 11.31 does not agree with the definition as subparagraph (b) refers in one case to foreign exchange risk and in the other case to foreign exchange risk and interest rate risk.

Plan assets – the definition of plan assets refers to a qualifying insurance policy, a term which is defined in IFRS but not in IFRS for SMEs. Consideration should be given to include the definition of a qualifying insurance policy.

Publicly traded – the word "registered" should start with a capital letter.

Useful life – the word "the" should start with a capital letter.