STATEMENT OF GAAP FOR SME’s: IMPLEMENTATION ISSUES
Background
It has been more than a year since the Statement of Generally Accepted Accounting Practice (GAAP) for Small and Medium-sized Entities (SMEs) has been approved by the Accounting Practices Board (APB).
This document, which is an exposure draft of a proposed International Financial Reporting Standard for Small and Medium-sized Entities (IFRS for SMEs), by the International Accounting Standards Board (IASB), was issued in South Africa as a Statement of GAAP for SMEs after consultation and due process in October 2007. The original text of the exposure draft of the IFRS for SMEs was adopted without any change. We are expecting that the final standard will be issued during Q1 2009, by the IASB and thereafter a revised Statement of GAAP for SMEs will also be issued.
A recent survey has indicated that 59% of respondents to the survey adopted or intend to adopt the Statement of GAAP for SMEs in the current financial year. Survey responses were received from 5155 limited interest companies as defined by the Corporate Laws Amendment Act, 2006 (CLAA), out of a possible 412000 active (Pty) Ltd companies of which an unknown number would be classified as limited interest and therefore be permitted to apply the Statement of GAAP for SMEs. Of the 41% that have not adopted the statements, 38% believe there is no material relief from full international Financial Reporting Standards (IFRSs) and South African Statements of Generally Accepted Accounting Practice (Statements of GAAP) and intend to adopt the final version when issued in 2009.
Scope
Most implementation queries relate to the scope of the Statement of GAAP for SMEs. In the South African environment there have been concerns that the scope paragraph of the Statement of GAAP for SMEs excludes organisations that we believe should be able to apply this; such as schools, charities, religious organisations, home owner associations, sectional title schemes and entities that hold assets in a fiduciary capacity as a sideline (i.e. not their primary business), such as travel agencies.
The Preface to the Statement of GAAP for SMEs, in paragraph 13, states that “decisions on which entities are required or permitted to use the IASB’s standards rest with national regulatory authorities and standard-setters”. Accordingly, the APB has decided that the Statement of GAAP for SMEs may be applied as follows:
- For companies: The Statement of GAAP for SMEs may be applied by ‘limited interest companies’, as defined in the CLAA, if they do not have public accountability as defined in Section 1 of the Statement of GAAP for SMEs.
- For entities other than companies where legal provisions or other regulations require compliance with a specific financial reporting framework (other than Statements of GAAP): such entities cannot apply the Statement of GAAP for SMEs even if they do not have public accountability as defined in Section 1 of the Statement of GAAP for SMEs.
- For entities other than companies whose financial reporting framework is not set out by legal provisions or other regulations: if such entities do not have public accountability, as defined in Section 1 of the Statement of GAAP for SMEs, they should assess whether it is appropriate to apply the Statement of GAAP for SMEs.
Paragraph 1.2 (b) of the Statement of GAAP for SMEs states that entities that “hold assets in a fiduciary capacity for a broad group of outsiders” are deemed to have public accountability. In paragraph 1.3, the Statement of GAAP for SMEs explicitly states that an entity may not state compliance with the Statement of GAAP for SMEs if it has public accountability, even if national laws or regulations permit or require the application of the statement for such entities.
The examples of entities that hold assets in a fiduciary capacity for a broad group of outsiders as noted in 1.2(b) of the Statement of GAAP for SMEs are banks, insurance entities, security brokers/dealers, pension funds, mutual funds or investment banking entities.
In May 2008, the IASB deliberated comments on the scope of the ED for SMEs and reported in the IASB Update that “an entity whose primary business is holding funds in a fiduciary capacity is publicly accountable and hence should be outside the scope of the standard. However, an entity that holds funds in a fiduciary capacity as a sideline to its principal business, for example a utility company or travel agency that takes deposits, should be permitted to use the standard if it otherwise qualifies”. Based on the above statement, it is not believed that it is the intention to scope out all entities that hold assets in a fiduciary capacity for a broad group of outsiders, such as schools, charities, religious organisations, home owner association, and sectional title schemes.
We have written to Paul Pacter (IASB’s Director of Standards for Private Entities) requesting that he asks the IASB to amend the wording of the scope of the final standard by stating that an entity has public accountability where its primary business is to hold assets in a fiduciary capacity, and to add the following sentence “The following entities would not normally be considered to have public accountability for the purpose of this standard: schools, religious organisations, charities, home owners associations, estate agents, travel agents and other entities as determined by national regulatory authorities and standard-setters. However, each entity’s circumstances would need to be assessed”. We believe this will make it more clear to know who can then apply the Statement of GAAP for SMEs.
In the meantime, entities should consider whether it is acceptable to apply a narrower interpretation of fiduciary capacity before this is included in the final standard. If such narrow interpretation is considered appropriate, we recommend that the following issues are also taken into consideration when determining if an entity indeed does have public accountability:
- Are the assets held on behalf of other parties for later ‘return,’ or are the assets held to operate a particular activity (such as schools)? i.e. a distinction between holding assets in a ‘custodial’ and ‘fiduciary’ capacity may be pertinent.
- Is the holding of assets in a fiduciary capacity a main business or only incidental to the main business, and not a significant part of the business?
- What mandate does the entity have to apply the funds held in a fiduciary or a custodial capacity?
Practical issues encountered
General
Major implementation issues identified during our workshops and responses received to the SAICA survey are highlighted below. A survey went out to all SAICA members, and the two main questions asked were what are the specific implementation issues being experienced and whether the respondents adopted or intend to adopt Statement of GAAP for SMEs.
SME businesses make limited use of revaluations of property, plant and equipment (PP&E) and defined benefit plans. There was also criticism regarding the usefulness of deferred tax, the required use of fair values for many financial instruments and the onerous requirements of PP&E accounting. Most respondents and course delegates do not believe consolidated accounts should be compulsory, but they rather be left to the discretion of the directors, with increased related party disclosures. Practical issues were identified during business combinations, and the resulting treatment of goodwill, as well as the requirement to identify intangible assets (with the probability criteria presumed to be met) and recognition of contingent assets. Lease ‘smoothing’ is generally disliked and most believe that fixed escalation clauses usually reflect inflation expectations.
It must be noted that the Statement of GAAP for SMEs was not developed for any specific user, such as SARS, banks or the owners of the business, but rather as general purpose financial statements intended to meet the needs of users that are not in a position to require an entity to prepare reports tailored to their particular information needs.
If an entity therefore moves from full IFRS or Statements of GAAP for SMEs, there is a measure of relief in terms of simplifications and less onerous disclosures, but for entities that previously applied ‘little gaap’ or other bespoke accounting policies, they will find the transition a huge jump. SAICA has commissioned a Micro GAAP Working Group, which includes preparers, users (SARS and the Banking industry), practitioners, accounting body representatives, regulators and other stakeholders in micro entity reporting to develop guidance for certain small and micro entities (still to be defined).
Property, plant and equipment
The Statement of GAAP for SMEs has given little to no relief in the property, plant and equipment section. Many believe the components approach will often prove too burdensome for SMEs. It was proposed that a SME depreciate all items of property, plant and equipment that are used in conjunction with one another for uniform use and purpose together, as though they were a single item.
It was also indicated that the cost model (subject to impairment) will prove the most cost-beneficial for SMEs. Very few SMEs revalue property, plant and equipment. Most importantly, it was suggested that the updating of residual values and useful life at least annually will prove unduly onerous. Perhaps this review could be eliminated or else be made conditional on an indicative trigger similar to that for impairment.
Fair value accounting
The survey indicated that the appropriate basis for measuring some SME assets and liabilities should be different from full IFRSs. While full IFRSs or Statements of GAAP focus on fair value, the Statement of GAAP for SMEs should adopt simplified measurement principles centored more on historic cost and impairment, if necessary.
Fair value data is often more difficult and costly to obtain and disseminate than historic cost. Due to the fact that there is not always ‘observable market data’, SMEs may have to resort to “valuation techniques” to determine suitable estimates. These estimates will lack the reliability of fair values based on observable prices.
At present, ‘undue cost or effort’. Easing the burden of using fair values by allowing SMEs to revert to using cost where fair values are not ‘readily determinable without undue cost or effort’ would implicitly embrace the notion of cost-benefit.
Intangible assets and goodwill
The Statement of GAAP for SMEs distinguishes between intangible assets with finite and indefinite useful life. It was recommended that, as a general rule, all intangible assets, including purchased goodwill, should be treated the same as other assets and accordingly capitalised and amortised. As well as reducing the need for an impairment test, since the book value of the assets would diminish over time, preparers would also be freed of the burden of having to demonstrate whether an asset has a finite or indefinite useful life.
The requirement to identify and recognise the fair values of intangible assets and contingent liabilities when effecting a business combination is also not found useful. It has been recommended that goodwill be written off over a limited period, such as ten or fifteen years.
Deferred tax
The initial exemption for the recognition of deferred tax on the acquisition of fixed assets with no wear and tear allowance has been removed from the SME standard. Therefore, the asset needs to be grossed up with the amount of deferred tax liability raised (see example 1). Most commentators believe this accounting treatment does not result in fair presentation.
This, together with the fact that the other sections of the standard do not give much relief, is the main reason for many limited interest companies not implementing the Statement of GAAP for SMEs.
Revenue recognition
The Statement of GAAP for SMEs requires measurement of revenue at the fair value of the consideration received or receivable, and specifically refers to deferred payment terms and the requirement to calculate the present discounted value of all future receipts determined using an imputed rate of interest. In the section dealing with financial assets and liabilities, it states that “Short-term receivables and payables with no stated interest rate may be measured at the original invoice amount if the effect of discounting is immaterial”. This also implies that prompt settlement discounts should be incorporated into the fair value calculation of such sales/debtors.
Although obvious financing transactions should be accounted for as such, many commentators believe it more appropriate to account for sales at the face value of the invoices. This may be accomplished by removing the reference to materiality. Discounting should only be required for receivables and payables arising from purchases and sales when payment is deferred beyond normal credit terms in a specific industry, or where normal credit terms in a specific industry are longer than six months. It should be made clear that items of a long-term nature should be discounted.
Benefits of adopting
Whilst it may not seem to be much relief for entities adopting the Statement of GAAP for SMEs regarding recognition, measurement and presentation requirements, there are, however, a lot less disclosure requirements, with full IFRS checklists having more than 3000 disclosure items, while the Statement of GAAP for SMEs has fewer than 400. A big portion of this reduction can be ascribed to the fact that the vast majority of IFRS 7 – Financial Instruments: disclosures, are not required in the Statement of GAAP for SMEs.
The IASB has committed to only update IFRS for SMEs ‘private entities’ every two years, and that it will not issue interpretations. Full IFRSs, however, are constantly changing with amendments to standards, new standards, exposure drafts and interpretations being issued. There are no fewer than 25 new or amended standards and interpretations that become effective in 2009, and the IASB’s timetable calls for publication by the IASB of 24 consultation documents and 23 final pronouncements between now and 2011, including; 6 Discussion Papers, 8 Exposure Drafts, 22 Final IFRSs and 1 Final Guidance. It is expected that more simplifications in recognition and measurement will be provided for in the final Standard.
Therefore, over time it will be easier to keep up to date with the Statement of GAAP for SMEs than following full IFRSs, which are becoming more complex. In addition, if an entity only applies the easier options in the Statement of GAAP for SMEs, it will not need to refer to full IFRSs or Statements of GAAP, and the resulting financial reporting complexity will be greatly reduced.
Allan Lombard CA(SA) is a director at W.Consulting and currently on a part-time secondment to SAICA to assist with the managing of the Micro GAAP project and consulting on IFRS for Private Entities.
