FRSME respondents give standard setters a headache

RESPONSES to the Accounting Standards Board consultation on financial reporting for SMEs (FRSME) are in, and they show that some groups are seriously worried.

More than one-third of the 290 responses came from housing associations and around 50 were sent by credit unions. Both groups fear the rules – a baby-brother version of International Financial Reporting Standards – will make far-reaching changes to their accounting practices and dump them at the bottom of the heap.

Credit unions are worried about being forced to play with the big boys, preparing accounts under full IFRS due to their classification as publicly accountable. This, they claim, is a disproportionate burden for a friendly local credit union.

Housing Associations’ objections are more complex, centring on the weakening of balance sheets by unfavourable changes to how assets are valued and loans accounted for. As well as making the associations appear financially weaker, they claim banks will jump at the chance to hike borrowing costs.

The Accounting Standards Board defined publicly accountable bodies as those that hold assets for, or take deposits from, a broad group of outsiders, among other things. It listed credit unions among the bodies belonging to this category, alongside banks, insurance companies and mutual funds.

Credit unions have highlighted their membership and legal structure to firmly refute the public accountability argument. Under the Credit Unions Act 1979, they have a cooperative legal structure and restricted membership, with only pre-determined individuals able to join. Additionally, each member has access to the union’s accounts and an equal say in how it is run, setting them apart from larger lenders.

The community lenders rolled out government endorsements as a further argument against reporting in full IFRS, saying that their “strong track record and internationally proven potential” for boosting the economy must not be stifled at such an early stage. They warned that members already have great difficulty reading their accounts, a problem that would only be exacerbated by a move to full IFRS.

Experts are sympathetic to the creditors’ arguments, saying the default position of reporting under full IFRS is too harsh. John Boulton, corporate reporting manager at the ICAEW, said that entities should be allowed to make a self-assessment using the three criteria of SME reporting: a balance sheet total under £3,260,000; net turnover below £6,500,000; and fewer than 50 employees on average over the financial year.

Currently, the ASB insists entities satisfy all three criteria to be classed as SMEs and exempted from full IFRS, yet credit unions have argued that two out of the trio should be enough. They claimed the cost of reporting alongside listed companies far outweighs the benefits because the groups have little interest in globally comparable accounts or attracting international investment.

Credit unions’ main concern is with keeping costs low through simple reporting requirements, which might be why experts are sympathetic to their complaints. Housing Associations’ qualms are less clear cut; some have accused them of courting favourable accounting standards.

The associations’ two main complaints centre on recording the cost of credit and the value of property. These issues are integral to asset-rich organisations such as social landlords that borrow heavily to buy, build and renovate accommodation.

Under both UK GAAP and IFRS, groups are able to capitalise the cost of borrowing, putting it on their balance sheets and allowing it to depreciate over the life of the loan. Under the proposed FRSME, loans would have to be expensed, meaning that they are entered on the income sheet in one lump sum. This could make groups’ financial status appear to lurch dangerously while also upsetting the gearing of the balance sheet.

At the same time, FRSME proposes that property should be recorded at cost price, meaning the value of housing that has appreciated over time or with substantial investment is not reflected in the accounts. Currently, revaluation is acceptable and widely used and housing associations are fighting are to keep this privilege.

They argued that capitalised cost and property revaluation reflect more faithfully a true picture of their accounts; additionally, they are concerned that the apparent sudden change in their financial health will push banks to raise borrowing costs, which could lead landlords to breach loan terms by default through ‘losing’ value on their assets.

A spokesman from the British Bankers’ Association said borrowing terms are based on the perceived level of risk involved and the cost to the bank of providing the funds: “Naturally, banks will be interested in the business’ balance sheet but, at the same time, they would be aware of any accounting changes that might have taken place.”

The question of whether or not banks will change loan conditions seems almost an issue of faith; lenders are well versed in accounting standards and should be able to see the ‘truth’ behind the figures beacuse landlords’ cash flows will be unchanged. However, in difficult economic times, it is reasonable for housing providers to worry about their fine-tuned balance sheets and the spectre of tightening purse strings.

ASB chairman Roger Marshall said dialogue with the unions and associations has been extensive and is ongoing. Sticking close to the established IFRS for SMEs framework, the body has striven to keep deviations to a minimum. Critics have argued that the UK already has a well-developed accounting standard for SMEs, whereas the global FRSME was developed for economies that are less advanced in this arena. On this basis, why dumb down guidelines for the sake of comparability with countries bearing little relation to the UK?

No other EU members use the global FRSME, and it is with these that UK SMEs would potentially value comparability. Marshall said it was more likely that major SMEs such as housing associations would appreciate comparability with larger IFRS-using peers, saying this is one argument for allowing them to keep their cherished options.

At its essence, the argument against dumbing down standards comes dangerously close to those of IFRS nay-sayers, who warn global rules are a step backwards and ignore national standards that have been developed over decades of trial and error. They may find more sympathy among nationally focused SMEs than major corporations but it is clear that the move is towards UK standards with a unified base.

It is ironic that the two most vociferous respondents are pulling in opposite directions. Housing associations are railing against the over-simplification of FRSME, saying they want to maintain the options available under full IFRS, while credit unions are clamouring for simple standards to keep admin and costs down.

Both desires arguably ignore the spirit of IFRS – to produce globally comparable accounts – but it could be that the ASB and the international standard setters are more willing to let this slide when it comes to SMEs. One thing is clear – the ASB has a job on its hands to produce a mutually satisfactory FRSME by the end of the year and there will always be malcontents.

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Fiona Westwood of Smith and Williamson.