Proposed changes will make accounting easy and simple

By Dr Jim Mcfie

Since the economic meltdown began in December 2007, and reached its zenith a little less than a year ago, fair-value accounting (‘mark to market’ as the Americans call it), has faced much criticism.

In October last year, the International Accounting Standards Board (IASB) published a document entitled "Reclassification of Financial Assets: Amendments to International Accounting Standard (IAS) 39 Financial Instruments: Recognition and Measurement and International Financial Reporting Standard (IFRS) 7 Financial Instruments: Disclosures".

This document did not go through the due process specified by IASB, but was produced in a hurry to cool down political temperatures raised by politicians attacking fair-value accounting.

It was also a surrender to banks that adopted IFRS models, but were forced to write down the values of their financial assets, as the full picture of the bad loan position in America became clear.

New Document

A few days ago, IASB published an exposure draft on financial assets, a document on which members of the public, accountants and financial analysts can air their views on the proposals made by IASB. This exposure draft will be developed into an International Financial Reporting Standard (IFRS) on the classification and measurement of financial instruments.

The new IFRS will not be published before 2010. IASB estimates that the first part of the new IFRS will not be mandatory until 2012 at the earliest. Instead of financial assets (for example, a loan given to a customer by a bank, or shares in a firm bought by an investing company) being divided into four different classes as at present, they will be divided into only two classes. These are loans, to be carried at (‘amortised’) cost, and others to be measured at "fair value". The Economist magazine of July 16, 2009 states: "This is far simpler than the existing system. But according to one bank’s finance chief, defining the boundary between the two types of assets is likely to prove tricky".

Another development occurred in accounting, but received scant coverage in the business press. On July 9, IASB published an International Financial Reporting Standard for ‘SMEs’ (Small and Medium-sized Enterprises) that will have a far greater effect on financial reporting, not only in Kenya, but also across the world.

The International Accounting Standards Boards (IASB) inherited the project from its predecessor organisation in 2001, when IASB came into existence. IASB started work on the task in 2003.

Chronology Of Events

Two discussion papers were published; one in mid-2004, and a second in early 2007.

Public round-table discussions with the Board of IASB took place in late 2005, after the IASB staff completed questionnaires on accounting modifications required for SMEs.

Issues arising over the document were discussed in 31 Board meetings of IASB. A complete exposure draft was posted on the IASB website in August 2006,and a revised one in November of the same year.

It was field tested by 116 small companies in 20 countries, and translated into five languages other than English (Swahili and Sheng versions were not included), after which the staff of IASB undertook a comprehensive outreach programme, that involved presentations at 104 conferences and roundtables in 40 countries; the document was deliberated upon in a further 13 meetings of the Board of IASB between May 2008 and April 2009.

In April this year, the Board decided that the name of the final standard would be "International Financial Reporting Standard for Small and Medium-sized Entities (IFRS for SMEs), as proposed in the original exposure draft. Last month, 13 of the 14 members of IASB voted in favour of the IFRS; on 9th July 2009 it was issued.

The Rationale

Asked why the new standard is called ‘IFRS for SMEs’ even though there is no test for company size in determining what entities are eligible to use it, Paul Pacter, Director of Standards for SMEs for IASB, states that IASB changed its working name several times during its five-year development process. SME was in the name at first, and then it was changed to NPAE — non-publicly-accountable entities.

Then, for a while, the standard was called "IFRS for Private Entities." But it was judged unsuitable because in many countries — including China, France, Sweden, and several in Latin America — it is common for the government to be a part owner of companies and to consider such companies to be public. IASB finally decided that no name was better than ‘IFRS for SMEs’.

Entities with "public accountability" cannot use the IFRS for SMEs. Entities falling into this definition are those in the process of filing their financial statements with a securities commission (the Capital Markets Authority in Kenya) or any other regulator, for the purpose of issuing any class of shares or bonds in a public market.

Also included are entities holding assets in a fiduciary capacity for a broad group of outsiders, for example, banks, insurance companies, brokers and dealers in shares and bonds, pension funds and unit trusts.

The IFRS for SMEs contains five types of simplifications of full International Financial Reporting Standards: some topics are omitted because they are not relevant to typical SMEs; for example, interim financial reporting, segment reporting, special accounting for assets held for sale and earnings per share;

Proposed Changes

Some accounting policy options in full IFRSs are not permitted in the IFRS for SMEs, because a more simplified method is available for SMEs:

Those not allowed include:

a) Financial instruments classified as available-for-sale, or held-to-maturity.

b) The revaluation model for property, plant and equipment and for intangible assets.

c) Proportionate consolidation for investments in jointly-controlled entities;

d) An accounting policy choice between the cost and fair value models for investment properties – they are valued by circumstance rather than by choice.

e) Various options for government grants

The five simplifications for SMEs in the IFRS are:

a) Financial instruments meeting specified criteria are measured at cost or amortised cost — all others are measured at fair value.

b) De-recognition of an asset or of a liability is based on a simple principle; hedge accounting is simplified: goodwill is always amortised over its estimated useful life, or 10 years if the useful life cannot be estimated reliably.

c) Investments in associates and joint ventures are measured at cost unless there is a published price of the shares in the investee, in which case, fair value must be used;

d) Research and development costs, and borrowing costs, must be recognised as expenses.

e) Accounting for property, plant and equipment, pensions, income tax and biological assets has been simplified; there are substantially fewer disclosures, and re-drafting has been simplified.

The result of these simplifications is that the IFRS for SMEs is a self-contained standard of about 230 pages, tailored for the needs and capabilities of smaller businesses.

To further reduce the reporting burden for SMEs, revisions to the IFRS will be limited to once every three years, as opposed to the yearly updates that are accorded full IFRS models (when the need arises).

Kenya’s case

The IFRS for SMEs is separate from full IFRSs and is therefore available for any jurisdiction to adopt whether or not it has adopted the full IFRSs. It is also for each jurisdiction to determine which entities should use the standard. The IFRS is effective immediately on issue.

A potential problem arises in Kenya. When the Council of the Institute of Certified Public Accountants of Kenya decided in 1997 to adopt International Accounting Standards (IAS models, now IFRS models) in Kenya for all accounting periods commencing on or after 1st January 1999, it decided that all entities in Kenya should prepare their financial statements in accordance with IASs (now IFRS models).

When an entity has to prepare its financial statements in accordance with the IFRS, it must ensure that the financial statements are in accordance with all applicable IFRS models.

The American Institute of Certified Public Accountants is encouraging small companies in the United States to use the IFRS for SMEs. Private companies not quoted on a stock exchange in the US could already choose IFRSs.

In fine, Accounting is becoming simpler – well, let us wait and see: it may be becoming simpler – but at least the lawmakers are aware that simplification is needed.

Dr. Jim McFie is the Academic and Research Director of Strathmore University, and head of the Audit Committee of The Standard Group Limited, publishers of this newspaper