Development of the International Financial Reporting Standard for Small and Medium-sized Entities

Abstract

This thesis examines how and why the International Accounting Standards Board (IASB) added the project on Small and Medium-sized Entities (SMEs) onto its active agenda, and examines the complete SME project to understand the IASB’s standard setting activity. This study covers events from March 2000 to July 2009 and is important because it is the first to examine the IASB’s agenda setting activity and accounting standard setting in such depth. Conventional thinking since the 1950s has been that one set of reporting requirements should be applicable to all entities, regardless of size. From the time of its establishment in early 2001 the IASB’s constitutional mandate was to “develop in the public interest a single set of high quality ... accounting standards ... to help participants in the various capital markets of the world” (IASB, 2004: para 8, emphasis added). In 2009, however, the IASB promulgated an accounting standard International Financial Reporting Standards (IFRS) for Small and Medium Entities (SMEs), that seemed to overturn this thinking. This research applies historical research methods, observation at key meetings and interviews to carry out this study. This study employs a wide range of documents relating to the SME project and observations of key meetings. It also goes beyond the evidence in the public domain and includes 32 interviews with key people with an interest and involvement in the development of the standard. It also draws on International Standard-setting Report (IStaR) documents that provide detailed observer accounts of the IASB board meetings. Kingdon’s (1984) policy oriented agenda setting framework provides a means of interpreting the research material obtained. This framework identifies three streams—problem, policy and politics— to understand how issues gain entrance onto a policy maker’s agenda, and is also useful for interpreting the more detailed policy formulation. Key findings of this thesis show that the SME project was opposed within the IASB by both some board members and senior staff, who did not believe that the IASB had the mandate to produce another set of standards. There was a possibility that the project could have been blocked or sidetracked by those opposed to the project. Sir David Tweedie, the chairman of the IASB, removed these obstacles by seeking a change in the International Accounting Standard Committee Foundation (IASCF)’s constitution and creating a new senior position to direct the project. The director of the SME project reported directly to Tweedie. A legacy issue inherited from the IASB’s predecessor, the International Accounting Standards Committee (IASC), noted a “strong demand exists for more work on the application of accounting standards to reporting by small enterprises” (IASC, 2000: para 29). As the IASB discussed this issue with its stakeholders, this potential project on SMEs was extended to include developing countries. Before the SME project was added onto the IASB’s agenda in July 2003, the project focus was narrowed to SMEs. The IASB assumed that SMEs and developing countries had similar reporting needs and that by developing the SME standard it would address the needs of developing countries. The IASB added the SME project onto its agenda for several reasons. The IASB was under external pressure to develop a simplified set of reporting standards for SMEs. There were also other groups, including the United Nations Conference on Trade and Development (UNCTAD), the European Financial Reporting Advisory Group (EFRAG), and the International Federation of Accountants (IFAC), which had indicated they would step into the IASB’s standard setting domain if the IASB did not ii commit to the SME project. This possibility seemed to be a threat to the IASB, which wanted to protect its standard setting domain. Even before adding the project on SMEs to its active agenda the IASB had identified its proposed policy proposal if it were to act which was to minimise divergence from full IFRS. When the IASB issued its discussion paper in June 2004, it identified multiple objectives for the project of which the two primary objectives were to focus on meeting the needs of users of SME financial reports, and to reduce the reporting burden on SMEs. One of the secondary objectives was to facilitate transition to full IFRS, and this secondary objective seemed to be consistent with the IASB’s earlier proposed policy to minimise divergence. During the course of the project the IASB increasingly concentrated on the secondary objective of facilitating transition to full IFRS. The IASB seemed to resist changes sought via the public due process that would have simplified the recognition and measurement criteria in the SME standard. However, private lobbying by other groups such as EFRAG seemed more influential in convincing the IASB to provide some recognition and measurement simplifications. The IASB claimed that it was developing a standard for SMEs that would also assist developing countries, but it used a narrowly defined concept of public accountability to determine which entities can use the eventual standard. SMEs were described as those entities that do not have public accountability and that publish general purpose financial statements for external users. An entity was deemed to be publicly accountable if it was trading in the public market to raise funds or if it was holdings assets in a primary fiduciary capacity. The criteria used to determine which entities can use the standard were inconsistent with the description of the standard’s target users. Those entities that meet the criteria will not necessarily be SMEs. Rather it will be those regarded as nonpublicly accountable, according to the IASB’s definition of public accountability. The board struggled to find an appropriate title for the standard that aptly described the scope of the standard. The title of the project was changed five times but eventually, two months before the standard was released, it was re-titled IFRS for SMEs, despite the IASB’s awareness that the title is inconsistent with the criteria used to determine which entities can use the standard. However, the title IFRS for SMEs was considered to be widely understood and to give a positive impression of the standard. This study makes four contributions to the accounting standard setting literature. First, this study responds to a gap in the literature in relation to how issues are added on to the IASB’s agenda. This study showed that the IASB may add a project onto its agenda for several reasons other than those described in its Due Process Handbook. Second, the study showed that the IASB had already identified its proposed policy before adding the project onto its agenda. During the course of the project it became apparent that the IASB may not be open to making substantial changes to its predetermined policy as part of its due process. Third, the literature identified the need to understand the role of the technical staff in defining and managing projects. This study showed that the role of the technical staff extends beyond acting as an intermediary on the technical aspects of the project and includes managing projects to build support for and to market projects. Fourth, this study is the first to use only Kingdon’s framework to examine standard setting process of an international accounting standard setting body—the IASB. By using the Kingdon’s framework this study has highlighted subtleties embedded in the IASB’s standard setting process. This provides a better understanding of IASB’s agenda entrance process and how it develops a standard after it is added onto its agenda.