Brian Shearer and Nigel Sleigh-Johnson.
Financial reporting by unlisted companies in the UK has reached a crossroads. The UK Accounting Standards Board (ASB) will before long take final decisions on International Financial Reporting Standards (IFRS) convergence that may alter the UK accounting landscape beyond recognition.
Those decisions will be heavily influenced by the final shape of the long-awaited 'IFRS for SMEs', which, despite its title, is being developed by the International Accounting Standards Board (IASB) not just for small and medium-sized entities as defined in UK law, but rather for all entities not deemed to be 'publicly accountable'.
It is often assumed in the UK that, if the IASB delivers a high quality product, it is likely to be considered a suitable replacement for the Financial Reporting Standard for Smaller Entities (FRSSE). In fact, it seems entirely possible that the IFRS for SMEs - albeit packaged reassuringly in a UK wrapper and possibly tweaked here and there by the ASB - could supplant the entire corpus of UK financial reporting standards.
The outcome of the project to develop a slim-line version of IFRS thus has profound implications for the future shape of the UK accounting regime, and deserves close attention from anyone with a stake in the future of UK financial reporting.
One of the key challenges faced by standard-setters seeking to establish a successful differential reporting regime is determining the relationship and boundaries between the simplified standard and the primary standards it is intended to simplify. In this article on differential accounting, we assess experience in the UK in dealing with this so-called 'fall back' issue, suggest possible improvements to the UK model and consider how IASB thinking is developing in this area.The UK experience
The FRSSE is widely used in the UK by eligible companies. Its success reflects a number of admirable qualities, including its clarity, relative brevity and its status as a 'one stop shop' - enhanced by the recent importation of the relevant requirements of company law. To a considerable degree, the standard has established the credibility of simplified financial reporting both in the UK and internationally.
So how does it measure up in terms of the clarity of the interface with full UK GAAP?
The final paragraph of the 'General' section of the 'Status of the FRSSE' states: 'Financial statements will generally be prepared using accepted practice and, accordingly, for transactions or events not dealt with in the FRSSE, smaller entities should have regard to other accounting standards and UITF Abstracts, not as mandatory documents, but as a means of establishing current practice.'
Further guidance to this effect is provided in Appendix IV to the standard.
Although FRSSE users are exempt from other standards, where the FRSSE does not provide guidance on certain types of transaction the accounts should be prepared in accordance with 'accepted practice … unless there were good reasons to depart from it'.
Perhaps not surprisingly, there is a significant level of uncertainty over the interpretation of these references to other UK standards within the FRSSE and to references to the FRSSE within other standards. Although in the majority of cases the routine nature of the transactions involved means that the question of referring to the full standards does not arise, this lack of clarity brings with it an unnecessary risk of poor accounting on the one hand and excessive cross-referral to Big GAAP requirements excluded from the FRSSE on the other. The suggestion (in para 2.5 of the FRSSE) that 'adequate explanation' should be given where 'there is doubt whether applying provisions of the FRSSE would be sufficient to give a true and fair view' does little to remedy this.
This state of affairs always was rather unsatisfactory. Indeed, the ICAEW has long advocated inclusion of a clearer and more prominent explanation in the main body of the FRSSE of the relevance of other accounting literature.
It would be possible for example to include expanded guidance immediately after the discussion on true and fair view and substance of transactions at the front of the main body of the standard. This could clarify the approach to be adopted where the FRSSE is silent on a topic addressed by a new or revised standard, and where the FRSSE contains explicit, older guidance on that topic.
We would now go further than this. Big GAAP seems destined to become ever more complex as convergence with IFRS gathers pace, even if in due course the simplified IFRS for SMEs is deemed a suitable replacement for existing UK standards. This gives rise to an urgent need to adopt a more radical approach to simplification for smaller UK companies.
We suggest that the ASB should, after appropriate consultation with constituents, recognise explicitly that cost:benefit considerations and the information needs of users of SME financial statements may mean that applying professional judgment in circumstances where the FRSSE does not address a particular accounting recognition or measurement issue results in accounting that differs from that prescribed under full GAAP.
Reference might be made in the new-style FRSSE to specific paragraphs in other standards dealing with certain complex transactions not encountered by the generality of FRSSE users, but it should be made abundantly clear that there is no general requirement to 'fall back' to full - increasingly IFRS-based - UK GAAP.International developments
It is encouraging that thinking at the IASB on differential accounting appears, slowly but surely, to be moving in a similar direction. In September 2004, the ICAEW wrote to the IASB regarding its SME project in stark terms: 'In our view the approach adopted by the board will fail to meet the needs of the majority of small businesses.' The fear was that simplification would be very limited and that frequent 'fall back' to full IFRS would be necessary.
Even a cursory glance at the 'staff draft' of the SME exposure draft on the IASB website - still under development, and pointedly 'not for comment' - shows that the international project has moved on a long way.
In particular, the 'fall back' issue is now addressed in a surprisingly imaginative way. Where the SME standard does not deal with a transaction or event, management will be required to refer to a hierarchy of accounting literature in which full IFRS features as the last recourse, as shown by the extract from the staff draft set out in the box (right).
In general, it should be possible to determine an appropriate accounting treatment by reference to the guidance in the SME standard on similar issues, or, failing that, to a number of 'pervasive principles' for SME accounting, usefully distilled from the IASB conceptual framework and set out in the draft standard.
It is true that a fair number of the sections of the current draft, particularly for more complicated accounting or situations, are a straight reference to full IFRS, for example on the revaluation of property, plant and equipment.
However, this will reduce the bulk of the IFRS SME book - already comprising 236 pages and still counting - and seems welcome, subject to the proviso that the IASB board and commentators on the eventual exposure draft will need to check carefully that the boundary between the simplified standard and the rigours of full IFRS appears to have been drawn in the right place.
The upshot of the current debates over IFRS convergence and SME accounting is likely to be a period of unprecedented change in UK accounting. We would encourage others with an interest in the financial reporting process to make their voices heard, and soon.
Brian Shearer is technical partner at Grant Thornton and chairman of the ICAEW working party on SME accounting. Dr Nigel Sleigh-Johnson is head of financial reporting at the ICAEW and was recently appointed to the Joint EFRAG/FEE group on IFRS for SMEs. The views expressed are their ownTHE SME HIERARCHY Paragraph 11.3 of the draft exposure draft
In making the judgment described in para 11.2 (where the standard does not specifically address a transaction, other event or condition), management shall refer to, and consider the applicability of, the following sources in descending order:
(a) the requirements and guidance in this standard dealing with similar and related issues; and
(b) the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses and the pervasive principles in section 2 Concepts and Pervasive Principles of this standard; and
(c) the requirements and guidance in IFRSs and Interpretations of IFRSs dealing with similar and related issues.