IMPLEMENTING INTERNATIONAL STANDARDS IN A DEVELOPING
COUNTRY: A CHALLENGE AND AN OPPORTUNITY
By: Russell Guthrie, IFAC Director, Quality Assurance and Member Body
Institute of Chartered Accountants of Nigeria
Lagos, Nigeria – May 11, 2007
Good afternoon ladies and gentlemen, distinguished guests. Before I start my remarks, may I offer my sincere thanks to the Institute Chartered Accountants of Nigeria for inviting me to present at this event. It is a privilege and a pleasure to be here. I also bring you warm greetings from IFAC President Fermin del Valle and IFAC Chief Executive Ian Ball.
I principally will speak about the challenges and opportunities in implementing international standards but would also like to cover a few other topics towards the end of my remarks.
Over the past several years, we have witnessed the increasing pace of convergence of national standards with international standards. When people speak about convergence there is often agreement at the conceptual level that convergence is a good thing. This thinking is often described in terms of the benefits that the successful implementation of a single set of international accounting standards should have:
? Greater comparability of financial information for investors;
? Greater willingness on the part of investors to invest across borders; ? Lower cost of capital;
? More efficient allocation of resources; and
? Higher economic growth.
I personally believe convergence is a good thing and a worthy objective. But in the recent years, this rush to embrace international standards has also highlighted some of the serious challenges that exist to achieving this goal.
First, many countries, particularly developing countries, have embraced IFRS in new legislation or regulation often at the prompting of the international and donor community. However, this adoption into law has often been done without adequate consideration of the scope of its application. The laws have often been written such that IFRS is required to be applied to all entities which are required to prepare financial statements for statutory purposes. This has obviously created an enormous burden on Small and Medium Enterprises as well the Small and Medium Practioners who supply audit services to these companies. In fairness, this may have also been a result of the lack of an international alternative set of standards for SMEs.
You will of course be aware of the current IASB-SME project that is currently in Exposure Draft which seeks to create a simplified set of accounting standards for non public interest entities. IFAC believes this is a very important project and indeed, represents an opportunity for the entire international community to provide their input and opinions.
On February 15 the IASB published for public comment the 254 page Exposure Draft (ED) of its International Financial Reporting Standard for Small and Medium-sized Entities (IFRS for SMEs). At the same time the IASB also
issued its Basis for Conclusions as well as Draft Implementation Guidance,
comprising Illustrative Financial Statements and Disclosure Checklist. The deadline for comments is October 1, 2007.
The stated objective of this project is to develop an IFRS to meet the needs of –
and intended for use only by – SMEs.
But how has the IASB defined an SME?
SMEs are defined as entities that (1) do not have public accountability and (2)
publish general purpose financial statements for external users. Examples of such external users include owners who are not involved in managing the business, existing and potential creditors (such as lenders and vendors), customers, and credit rating agencies.
An entity has public accountability (and therefore should use full IFRSs) if:
; it has filed, or it is in the process of filing, its financial statements with a
securities commission or other regulatory organization for the purpose of
issuing any class of instruments in a public market; or
; it holds assets in a fiduciary capacity for a broad group of outsiders, such as a
bank, insurance company, securities broker/dealer, pension fund, mutual fund
or investment bank.
While the IASB has not specified a quantified size test, jurisdictions adopting the IFRS for SMEs may add one.
Why has the IASB developed a financial reporting standard for SMEs? The IASB gives a number of reasons:
First to provide a simplified, self-contained set of standards that are appropriate for smaller, non-listed companies while still based on full IFRSs, with modifications based on user needs and cost-benefit considerations. Second to remove choices for accounting treatment, eliminate topics that are not generally relevant to SMEs, and simplify recognition and measurement, thereby allowing it to shrink the volume of the standard by over 85% compared to full IFRSs. Third to enable investors, lenders, and others to compare SMEs’ financial performance, financial condition, and cash flows while, at the same time, reducing the burden of preparing SME financial statements. Fourth to provide emerging economies with an internationally recognized basis for financial reporting, helping to significantly raise standards in many countries whilst offering a clear upgrade path to full IFRS compliance. Fifth to ensure that the IFRS for SMEs results in general purpose financial statements on which an auditor can give an opinion as to fair presentation (or true and fair view) of financial position, performance, and cash flows. Sixth to redraft and simplify the language using plain English where possible so as to help SMEs prepare their financial reports. And finally, to develop a standard that will be suitable for, and easily applied by, even the smallest of SMEs – the so-called micro-entities with just a few employees. A rigorous due process has been followed during the 3 years developing the ED. Starting in September 2003 the IASB surveyed world accounting standard-setters on the key issues. Then in June 2004 it published a Discussion Paper, Preliminary Views on Accounting Standards for SMEs. The responses formed
the basis for the Staff Questionnaire on Possible Recognition and Measurement
Modifications for SMEs issued in April 2005. Over 100, including IFAC,
responded to each of these documents. In October 2005 respondents, including IFAC, had the opportunity to present to the IASB their views, in public round-table meetings, on possible recognition and measurement simplifications. The project has also been discussed at over 30 public Board meetings and 6 Standards Advisory Council meetings.
Intent on getting input from various stakeholders a Working Group was formed.
The Working Group comprises over 30 representatives of users and preparers drawn from all over the world. The members provide views and comments on specific issues that are presented to them. The Working Group has met 3 times and provided written comments on an internal draft of the ED. The Working Group will meet again to consider comments on the ED and make
recommendations to the IASB.
The ED was developed by extracting the fundamental concepts from the IASB
Framework for the Preparation and Presentation of Financial Statements and the
principles and related mandatory guidance from IFRSs with appropriate modifications in the light of needs of users of SME financial statements and cost-benefit considerations. While drafting the standard staff had in mind a typical SME with about 50 employees. In the interests of making the document stand-alone, there is no mandatory fallback to full IFRSs for topics not addressed in the standard.
What are the modifications from full IFRS?
The modifications are of 3 broad types:
First, IFRS topics not relevant to a typical SME are omitted, with cross-
references to the IFRS if needed. These include:
; General price-level adjusted reporting in a hyperinflationary environment; ; Equity-settled share-based payment (the computational details are in IFRS 2
; Determining fair value of agricultural assets (look to IAS 41 Agriculture, but
the ED also proposes to reduce the use of fair value through profit or loss for
Extractive industries (look to IFRS 6 Exploration for and Evaluation of Mineral ;
; Interim reporting (look to IAS 34 Interim Financial Reporting);
; Lessor accounting finance leases (finance lessors are likely to be financial
institutions who would be ineligible to use the IFRS for SMEs anyway); ; Recoverable amount of goodwill (SMEs would test goodwill for impairment
much less frequently than under IAS 38 Intangible Assets, but if an SME is
required to perform such a test it would look to the calculation guidance in IAS
; Earnings per share and segment reporting, which are not required for SMEs,
and Insurance contracts (insurers would not be eligible to use the IFRS for
Second, where full IFRSs provide an accounting policy choice, only the simpler
option is in the IFRS for SMEs. An SME is permitted to use the other option by cross-reference to the relevant IFRS. These include:
; Cost-depreciation model for investment property (fair value through profit or
loss is permitted by reference to IAS 40 Investment Property).
; Cost-amortization-impairment model for property, plant and equipment and
intangibles (the revaluation model is allowed by references to IAS 16 Property,
Plant and Equipment and IAS 38).
; Expense borrowing costs (capitalization allowed by reference to IAS 23
; Indirect method for reporting operating cash flows (the direct method is
allowed by reference to IAS 7 Cash Flow Statement).
; One method for all grants (or an SME can use any of the alternatives in IAS
20 Government Grants and Disclosure of Government Assistance).
In adopting the IFRS for SMEs, an individual jurisdiction could decide not to allow the option that is cross-referenced to full IFRS.
Third, recognition and measurement simplifications, including:
; Financial instruments:
o There are 2 categories of financial assets rather than 4. This means there
is no need to deal with all of the intent-driven held to maturity rules or
related 'tainting', no need for an available for sale option, and many other
o There is a clear and simple principle for de-recognition - if the transferor
has any significant continuing involvement, do not derecognize. The
complex 'pass-through testing' and 'control retention testing' of IAS 39
Financial Instruments: Recognition and Measurement are avoided.
o Much simplified hedge accounting.
; Goodwill impairment - an indicator approach rather than mandatory annual
; Expense all research and development cost (IAS 38 would require
capitalization after commercial viability has been assessed).
The cost method for associates and joint ventures (rather than the equity ;
method or proportionate consolidation).
; Less fair value for agriculture - only used where 'readily determinable without
undue cost or effort'.
; Defined benefit plans - a principle approach is used rather than the detailed
calculation and deferral rules of IAS 19 Employee Benefits. The complex
'corridor approach' is omitted.
; Share-based payment – only the intrinsic value method.
; Finance leases - simplified measurement of lessee's rights and obligations.
; First-time adoption - less prior period data would have to be restated than
under IFRS 1 First-time Adoption of IFRSs.
In order to ease the burden on preparers the IFRS for SMEs will be updated, of
required, approximately once every two years via an 'omnibus' exposure draft. And it is organized topically, rather than in IAS/IFRS statement number
sequence. It has 38 sections and a glossary.
What then are the next steps?
The exposure period ends on October 1, 2007. The IASB plans to issue a final IFRS for SMEs in the second half of 2008. During the exposure period the IASB will conduct round-table meetings with SMEs and small firms of auditors to discuss the proposals. The IASB also intends to undertake field visits and/or field tests of the proposals in the ED.
So what role is IFAC playing in the IASB’s SME project?
At its last meeting the IFAC Board indicated its strong support for this project and vowed to assist the IASB in various ways so as to secure an optimal outcome.
First, IFAC will respond to the ED. The response will take a global public interest perspective. The IFAC SMP Committee has been asked to lead the drafting and as it does will consult with relevant stakeholders including other IFAC committees and regional accountancy organizations.
Second, IFAC, through its SMP Committee, will assist the IASB in the conduct of these field tests. Once the field test kit is made available by the IASB, the SMP Committee will circulate and otherwise promote its use.
Third, IFAC has encouraged its member bodies and regional accountancy organizations to contribute to the debate by responding to the ED and participating in IASB orchestrated roundtables and field tests. I strongly encourage the Institute to both participate in the field test and respond to the ED.
Finally, IFAC recognizes that often the users and preparers of SME financial statements do not get involved in the international standard-setting process for accounting, assurance and ethics. Hence IFAC, through its communications vehicles and other outreach efforts, is actively encouraging such groups to participate.
Now let me focus on the SMP Committee’s work in this area. We have
been closely following the project ever since it started back in 2003. We helped draft the IFAC responses to the aforementioned Discussion Paper and Staff Questionnaire. And SMP Committee Staff had the opportunity to participate in the IASB public round-table meetings. In addition, two of our members sit on the IASB SME Working Group that offers guidance to the IASB.
We are looking for a globally applicable SME standard, consistently implemented. The guidance must ease the compliance burden on SMEs and ensure that the benefits from using SME financial reports exceed the costs of preparing, disseminating and using them. The release of the ED marks a