Tuesday, October 4, 2011

The Meaning & Significance of 'Undue Cost or Effort,' 'Impracticable' in Accounting Standards; IASB Draft Q&A

Among five draft Q&As relating to International Financial Reporting Standards for Small and Medium Sized Entities (IFRS for SMEs) released for public comment by the IASB last week, the one that piqued my interest in particular was: Interpretation of ‘Undue Cost or Effort’ and ‘Impracticable.’

The IASB’s draft Q&A pertaining to IFRS for SMEs states:

‘Impracticable’ is defined in the IFRS for SMEs as follows: ‘Applying a requirement is impracticable when the entity cannot apply it after making every reasonable effort to do so. ‘Impracticable’, therefore, generally only covers situations where information is unavailable, for example where data, that has not been collected at the time of an event, is impossible to create at a later point, rather than situations where the data could be obtained but it would be expensive or time consuming to do so. ’….

…. Impracticable is defined in the IFRS for SMEs in the same way as under full IFRSs. The definition refers to effort, but not to cost. Therefore, some people have concluded that if the data required in order to apply a principle in an IFRS can be obtained, an entity must do so regardless of cost….

It could be argued that ‘every reasonable effort to do so’ would not include spending excessive resources in order to comply with a requirement. However, enquiries to the IASB concerning the difference between ‘impracticable’ and ‘undue cost or effort’ suggest that the IFRS for SMEs is not clear as to whether cost alone would render a requirement impracticable.
Undue Cost or Effort
Further, the draft Q&A pertaining to IFRS for SMEs states:

‘Undue cost or effort’ is deliberately not defined in the IFRS for SMEs as it will depend on the SME’s specific circumstances and management’s professional judgment in assessing the costs and benefits. That assessment should include a
consideration of how the economic decisions of the users of the financial statements could be affected by the availability of the information. Applying a requirement would result in ‘undue cost or effort’ because of either excessive cost (e.g. through valuers’ fees) or excessive endeavors by employees in comparison to the benefits that the users of the SME’s financial statements would receive from having the information.

…Where ‘undue cost or effort’ is used together with ‘impracticable’, this should be applied in the same way as ‘undue cost or effort’ on its own. ‘Undue cost or effort’ is used either instead of, or together with, ‘impracticable’ for certain requirements in
the IFRS for SMEs in order to include cost or burden as factors to take into
account when deciding whether to obtain or determine the information.

To include an exemption for impracticability alone would mean that an SME would be required to follow the requirements if it is possible to obtain or determine the information, regardless of the cost or effort required. For example, an SME would be expected to engage a valuer, actuary or other professional to make a particular measurement, regardless of the cost, provided the valuer expects to be able to develop a reliable valuation of the asset.

… The inclusion of ‘undue cost or effort’ for certain requirements in the IFRS for SMEs is intended to clarify that cost is a consideration when applying that requirement. Although there is no direct reference to benefits in the term, in order to assess whether cost and effort is ‘undue’ SMEs would have to make an assessment of how important the information is to users.
Why Does This Matter?
My two cents (please note the disclaimer posted on the right side of this blog): Although IFRS for SMEs, a condensed, simplified, and self-contained set of IFRS, about 1/10 the size of full IFRS, may be elected for use (e.g., as an alternative to full IFRS, or, theoretically, as an alternative to U.S. GAAP) by private companies only (i.e., those that are not publicly listed , and even then, only those that do not have ‘public accountability’ such as banks and certain other entities), I believe this draft Q&A is something worth studying and watching how it evolves, whether you work for (or are indirectly involved in some capacity such as auditing or investing in) a private company or public company, and whether you that company (ies) follow IFRS or U.S. GAAP.

Here is why: The Draft Q&A notes that the definition of the term ‘impracticable’ applicable to IFRS for SMEs is the same as that in full IFRS. Therefore it will be interesting to see if any potential changes to the definition applicable to IFRS for SMEs would then raise questions with regard to whether the definition of ‘impracticable’ in full IFRS (as well as usage of ‘undue cost and effort’ in full IFRS) should be considered/reconsidered. Thus, with potential engagement of consideration of implications for full IFRS, the private co/public co (or small co/large co) dividing line may not be as relevant.

Similarly, with convergence a priority – although on particular matters the FASB and the IASB can ‘agree to disagree,’ it will be interesting to see if the consideration/reconsideration of the definitions of these key terms will take place at some future date in a parallel manner by the FASB and its constituents.

Why does this matter? The significance of the terms ‘undue cost or effort’ and ‘impracticable’ in terms of accounting standard-setting, is that development of (and revision of) GAAP standards theoretically takes into account cost-benefit considerations, and the above terms are sometimes specifically used in defending or arguing against particular accounting treatments. In certain instances, ‘practicability’ exceptions are also provided, and those exceptions do not necessarily relate only to private companies or small companies, particularly if ‘new information’ has to be developed to satisfy a particular accounting requirement, which cannot readily be recreated after-the-fact (this point relates particularly to the transition method or method of adoption set forth in a new standard(s), such as retroactive, retrospective, or current/going-forward basis).

I would add that, again in my personal opinion, in terms of a common sense definition of ‘impracticable,’ (although I am not certain how this lines up with any definition(s) of the term in existing U.S. GAAP standards or concept statements, or in the FASB’s Standards of Procedure which govern how they set standards, and I would welcome anyone to provide insights they have via a comment on this blog or an email to me), I would not have thought that a cost of something close to ‘infinity’ would not be considered as rendering a particular requirement ‘impracticable,’ even if it is theoretically ‘possible’ to obtain/develop/recreate said information. In fact, if impracticable meant ‘impossible’ if not used in conjunction with ‘without undue cost or effort,’ then I would think that the term perhaps should never be used alone, without the ‘undue cost or effort’ proviso. What do you think?

The comment deadline on the five draft Q&As on IFRS for SMEs released for comment on September 28, will end November 30. See related press release.
In related news on the private company front, see our post earlier today, FAF Proposes Private Co Standards Improvement Council To Modify GAAP For Private Co’s – PCSIC’s Recommendations Would Be Subject To Public Comment, FASB Ratification . See also: Plan to Simplify US Private Company Accounts by Helen Thomas in the Financial Times published earlier today, and Big GAAP/Little GAAP: A Possible Solution? published 12/21/10 in the Cherry, Beckaert & Holland Blog.

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Alexander Shekaroff said...

‘Undue cost or effort’ is deliberately not defined in the IFRS for SMEs.... great


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