4. Financial Instruments and Equity under IFRS for SMEs (Sections 11, 12, 22)

1. IFRS for SMEs: Foundation and Entry Rules (Sections 1, 2, 35).
2. IFRS for SMEs: Presentation of Financial Statements (Sections 3–10, 31–33).
3. IFRS for SMEs: Accounting for Non-financial Assets (Sections 13–20, 27, 34).
4. IFRS for SMEs: Financial Instruments and Equity (Sections 11–12, 22).
5. IFRS for SMEs: Income, Liabilities, and Taxes (Sections 21, 23–26, 28–30).

Introduction

The IFRS for SMEs Accounting Standard is the result of years of work by the International Accounting Standards Board (IASB) to create a simplified but holistic conceptual framework for entities that do not have public accountability. Unlike the full suite of IFRS Standards, which is oriented towards participants in global capital markets, IFRS for SMEs focuses on the needs of users of private company financial statements, such as lenders, vendors, and owner-managers.

In Ukrainian realities, where the majority of enterprises are classified as medium-sized, the transition to this Standard is a tool for increasing investment attractiveness, while official translations provide the necessary regulatory basis.

The central and simultaneously most complex element of the accounting model for SMEs is accounting for financial instruments and equity. In the current version (2015), these issues are regulated by three sections:

• Section 11 “Basic Financial Instruments”
• Section 12 “Other Financial Instrument Issues”
• Section 22 “Liabilities and Equity”

Comparative analysis with Full Standards (IFRS 9, IAS 32) demonstrates conceptual unity; however, IFRS for SMEs offers significant methodological simplifications (“cost-benefit approach”), which reduces the burden on finance departments.

Conceptual Structure and Choice of Accounting Policy for Financial Instruments

For financial management, understanding the dilemma embedded in Paragraphs 11.2 and 12.2 of the current Standard is critically important. An entity has an accounting policy choice:

1. Option 1 (Standard Approach): Fully comply with the requirements of Sections 11 and 12 of IFRS for SMEs.
2. Option 2 (Alternative Approach): Apply the recognition and measurement provisions of IAS 39 “Financial Instruments: Recognition and Measurement” and the disclosure requirements of IFRS for SMEs.

This option is a historical compromise: although in the world of Full IFRS, IAS 39 has already been replaced by IFRS 9, it remained available for SMEs as a “lifeline” for companies with complex instruments. However, this compromise has run its course.

Section 11: Basic Financial Instruments — The Foundation of SME Financial Stability

Section 11 focuses on those instruments most frequently encountered in the business activities of SMEs: cash, trade receivables and payables, deposits, promissory notes, and loans. The concept of “Basic” is a key simplification tool, as it allows the use of the amortized cost model for the vast majority of assets and liabilities, avoiding the volatility inherent in fair value measurement.

Classification Criteria and Comparison with IFRS 9

In Full IFRS 9, the classification of financial assets is based on a combination of the entity’s Business Model and the Contractual Cash Flow Characteristics test (the SPPI test — Solely Payments of Principal and Interest).

In Section 11 of IFRS for SMEs, the approach is more directive: the Standard provides a list of conditions that a debt instrument must meet to be considered “basic.”

According to Para 11.9, a debt instrument satisfies the criteria for a basic instrument if the return to the holder is a fixed amount, a fixed rate of return over the life of the instrument, or a variable rate that is a single quoted or observable interest rate (e.g., NBU Key Policy Rate, EURIBOR, or SOFR). Any presence of contingent returns or prepayment provisions that are not protective for the holder against credit risk changes removes the instrument from the scope of Section 11 and places it into the scope of Section 12.

Deep Analysis: IFRS for SMEs effectively eliminates the categories “Held-to-maturity” and “Available-for-sale” which existed in IAS 39, simplifying accounting to two main models: Amortized Cost and Fair Value through Profit or Loss.

Initial and Subsequent Measurement at Amortized Cost

Initial measurement of basic financial instruments is made at the transaction price unless the arrangement constitutes a financing transaction. If payment is deferred beyond normal business terms (e.g., an interest-free loan for three years), the entity shall measure the asset at the present value of the future payments discounted at a market rate of interest.

Note for Ukrainian Accountants: This is a critical point, as providing financial assistance between related parties often occurs on non-market terms, which requires the recognition of a discount in equity or income/expenses.

Subsequent measurement is carried out at amortized cost using the effective interest method. The Standard details this method in Paras 11.15–11.20, where the effective interest rate (EIR) is defined as the rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial instrument to the carrying amount at initial recognition.

Mathematical Basis of Calculation:

To calculate the amortized cost and EIR, the Present Value (PV) formula is used:

BV = \sum_{t=1}^{n} \frac{CF_t}{(1+r)^t}

Where:

BV — Book Value (Carrying Amount);
CF_t — Cash Flow in period t;
r — Discount rate (Effective Interest Rate);
n — Number of periods.

To calculate the subsequent measurement (roll-forward), we use the following formula:

AC_{end} = AC_{start} + (AC_{start} \times r) - P

Where:

AC_{end} — Amortized cost at the end of the period;
AC_{start} — Amortized cost at the beginning of the period;
r — Effective interest rate (per period);
P — Actual cash payment/receipt (nominal interest + principal) in this period.

Practical Examples and Impairment

PV = \frac{100,000}{(1+0.20)^2} = \frac{100,000}{1.44} = 69,444 \text{ UAH}

Simplification for SMEs: Current assets and liabilities (e.g., trade receivables due within one year) are measured at the undiscounted amount unless the arrangement constitutes a financing transaction. In Full IFRS 9, a similar simplification exists only for trade receivables without a significant financing component under IFRS 15.

Impairment of Financial Assets: A Conceptual Gap

One of the most radical differences between IFRS for SMEs and IFRS 9 is the impairment model. Section 11 continues to be based on the “Incurred Loss Model” borrowed from IAS 39. This means an entity recognizes an impairment loss only when there is objective evidence of a loss event that occurred after initial recognition.

Evidence of impairment under Para 11.22 includes:

• Significant financial difficulty of the debtor;
• A breach of contract (default or delinquency in payments);
• The creditor granting a concession to the debtor that would not otherwise be considered;
• High probability of bankruptcy of the debtor.

In contrast, Full IFRS 9 requires the application of the “Expected Credit Loss” (ECL) model, which is forward-looking in nature. Under ECL, an entity must recognize 12-month expected losses immediately upon recognition (Stage 1), and lifetime expected losses upon a significant increase in credit risk (Stages 2 and 3).

Section 12: Other Financial Instrument Issues and Derivatives

Section 12 covers complex instruments such as warrants, options, swaps, forwards, and investments in non-convertible preference shares and non-puttable ordinary shares or preference shares that do not meet the conditions of Section 11. The main requirement of this section is measurement at Fair Value through Profit or Loss (FVTPL).

Simplification of Embedded Derivatives Accounting

A significant feature of IFRS for SMEs is the simplification of accounting for embedded derivatives. In Full IFRS 9, entities are often forced to separate (bifurcate) embedded derivatives from the host contract if they are not closely related.

In IFRS for SMEs, the concept of separating an embedded derivative does not exist: if an instrument contains an embedded element that causes its cash flows not to meet the criteria of a basic instrument, the entire hybrid instrument is measured at Fair Value through Profit or Loss.

Hedge Accounting in a Simplified Model

Section 12 permits the application of hedge accounting to match the timing of the recognition of gains and losses on the hedging instrument and the hedged item. However, the scope of hedging in SMEs is significantly narrower than in IFRS 9 or even IAS 39.

Permitted Risks for Hedging (Para 12.17):

1. Interest rate risk of a debt instrument measured at amortized cost.
2. Foreign exchange risk or interest rate risk in a firm commitment or a highly probable forecast transaction.
3. Price risk of a commodity that the entity holds or intends to buy/sell.
4. Foreign exchange risk in a net investment in a foreign operation.

Compared to IFRS 9, IFRS for SMEs excludes the possibility of hedging net positions or aggregated risks in such a flexible manner. Furthermore, only certain types of swaps and forwards can serve as hedging instruments.

Benefit: This model is significantly more accessible for SME CFOs as it focuses on the most critical risks and does not require complex mathematical tests on retrospective effectiveness, which were mandatory under IAS 39.

The “Undue Cost or Effort” Concept

This is one of the most specific concepts of IFRS for SMEs, running through all sections, including 11, 12, and 22. Paragraph 11.14 explicitly states that if an investment in equity instruments cannot be measured at fair value without undue cost or effort, it shall be measured at cost less impairment.

In the full suite of IFRS Standards (specifically IFRS 13), the concept of “undue cost” is practically not used as an exemption from fair value measurement. Professional judgment regarding what constitutes “undue” must be based on weighing the benefits to users against the costs to the entity. The entity is required to disclose the reasons for using this exemption, which serves as an important signal to auditors and lenders about limited access to market information.

Section 22: Liabilities and Equity – The Boundary of Financial Structure

Section 22 regulates the classification of instruments issued by an entity as either financial liabilities or equity. This distinction is critical for calculating financial stability ratios (leverage) and understanding investor rights.

Classification: Substance over Form

Just like in IAS 32 “Financial Instruments: Presentation,” the primary principle in SMEs is classification based on the substance of the contractual arrangement, not merely its legal form. A financial instrument is a liability if the entity does not have an unconditional right to avoid delivering cash or another financial asset.

The most complex aspect is accounting for puttable instruments. Although the holder’s right to return the share to the company usually creates an obligation, Paras 22.4 and 22.5 provide an exception: such instruments are classified as equity if they represent the most residual interest in the net assets of the entity upon liquidation. This is particularly relevant for cooperatives or investment funds where members have a right of withdrawal.

Fig. 1. Classification of Preferred Shares under IFRS for SMEs

Compound (Hybrid) Financial Instruments

IFRS for SMEs requires the application of “split accounting” for instruments containing both liability and equity components (e.g., convertible bonds). The mechanism is identical to IAS 32:

1. Determine the liability amount as the fair value of a similar instrument without the conversion right.
2. The residual amount of the proceeds is allocated to equity.

Note: This approach ensures the value of the conversion option is reflected directly in equity at issuance and is not remeasured in subsequent periods.

Extinguishing Financial Liabilities with Equity Instruments

Paras 22.15A–22.15B introduce rules into the SME Standard analogous to IFRIC 19 “Extinguishing Financial Liabilities with Equity Instruments.” In debt restructuring conditions, an entity may issue its own shares to settle with a creditor (Debt-for-Equity Swap).

Main requirements:

• Issued equity instruments are measured at fair value.
• The difference between the carrying amount of the financial liability extinguished and the fair value of the equity instruments issued is recognized in profit or loss as a gain or loss.
• If the fair value of the shares cannot be measured reliably, the fair value of the liability extinguished is used.

Implication: This provision is extremely important for accountants during periods of economic instability, as it clearly distinguishes transactions with owners (which do not affect profit) from transactions with creditors (which generate restructuring gains).

Treasury Shares and Distributions of Non-cash Assets

Section 22 also contains clear instructions regarding transactions common in corporate practice:

1. Treasury Shares: The cost of treasury shares must be deducted from equity. The entity is categorically prohibited from recognizing any gain or loss on the purchase, sale, issue, or cancellation of the entity’s own equity instruments in profit or loss. All financial consequences of such transactions are reflected exclusively through changes in equity.
2. Distributions of Non-cash Assets (Distributions in Specie): When an entity distributes assets (e.g., property, plant and equipment or inventories) as dividends, it must recognize a liability at the fair value of those assets. This aligns with the requirements of IFRIC 17 “Distributions of Non-cash Assets to Owners.” Upon settlement, the difference between the carrying amount of the assets distributed and the carrying amount of the dividend payable is recognized in profit or loss.
   • Exemption for SMEs: If the fair value of the assets cannot be measured without undue cost or effort, the liability is measured at the carrying amount of the assets.

Disclosure Requirements: Focus on Materiality

IFRS for SMEs significantly reduces the volume of disclosures compared to IFRS 7 “Financial Instruments: Disclosures.” Specifically, SMEs are not required to provide detailed quantitative sensitivity analysis to market risks (VaR analysis, etc.) or complex disclosures regarding liquidity risk management, which are mandatory for public companies.

Key Disclosure Items under Paras 11.41 and 12.26:

• Total carrying amount of each category of financial assets and liabilities (amortized cost, FVTPL).
• Terms and conditions of debt instruments (rates, maturity dates, repayment schedules).
• Basis for determining fair value and assumptions used in valuation techniques.
• Information about defaults and breaches of loan covenants.
• Description of hedging strategies and the recognition of ineffectiveness.

Benefit: This allows users to understand the entity’s financial position without overloading the report with technical details understandable only to a narrow circle of market analysts.

Ukrainian Context: Ministry of Finance and Current Translations

For accountants and CFOs in Ukraine, working with IFRS for SMEs is inextricably linked to the official resources of the Ministry of Finance of Ukraine (MinFin). The MinFin website provides access to full texts of the standards in Ukrainian, which is mandatory for use under the Law of Ukraine “On Accounting and Financial Reporting.”

As of 2025, Ukrainian enterprises must be guided by the 2015 Edition with officially published amendments. Using the 2024 translations ensures the compliance of Ukrainian reporting with global standards in terms of terminology and methodology. For professionals, this necessitates verifying whether the company’s internal accounting policy aligns with current Ukrainian texts, especially regarding interpretations integrated into the main text of the standards.

Comparative Table of Methodological Differences

Below is a consolidated analysis of key differences, which can be used as reference material for management decision-making.

Future Prospects: Third Edition of the IFRS for SMEs Accounting Standard (2025–2027)

The IASB has recently completed the second comprehensive review of the Standard for SMEs, leading to the publication of the Third Edition in February 2025. Although this Standard will be effective for reporting periods beginning on 1 January 2027, CFOs should consider these changes now when planning long-term accounting strategies.

These changes indicate that the Standard continues to evolve towards convergence with Full IFRS Standards, but maintains its unique identity as a tool oriented towards practicality and resource economy.

Practical Recommendations for Managers and Accountants

For the effective implementation and application of Sections 11, 12, and 22, professionals are recommended to follow this algorithm:

1. First, conduct an inventory of all financial instruments of the entity and verify their compliance with the “basic” conditions according to Para 11.9. Particular attention should be paid to loans with variable rates and lease agreements, which may contain conditions requiring a transition to Section 12.
2. Second, clearly document the methodology for calculating amortized cost. The effective interest method requires a reliable system for accounting for discounts, premiums, and transaction costs, which must be amortized over the life of the instrument, not recognized immediately.
3. Third, in the equity section (Section 22), it is important to correctly identify compound instruments. If a company issues shares with mandatory redemption or convertible loans, the accounting department must perform “split accounting” at the moment the agreement is signed to avoid distorting equity figures.
4. Fourth, when working with receivables, ensure the collection of objective evidence of impairment. Since the ECL model is not applied, it is important for the accountant to have documentary proof of the debtor’s financial difficulties to recognize a loss in the report, which is critical for tax accounting in Ukraine.
5. Finally, constant monitoring of updates on the Ministry of Finance of Ukraine website will allow for timely responses to changes in translations and official clarifications, ensuring high-quality financial reporting and trust from users.

Conclusions: A Balanced Approach to Financial Reporting

IFRS for SMEs (Sections 11, 12, and 22) offers a holistic and logical model for accounting for financial instruments and equity, combining the rigor of Full IFRS principles with the practicality of rules adapted to the capabilities of medium-sized businesses. The main advantages of this model are the absence of volatility from ECL modeling, simplified accounting for derivatives, and flexibility in using the “undue cost or effort” concept.

Comparative analysis with IFRS 9 and IAS 32 demonstrates that the SME Standard successfully eliminates those aspects of accounting that are overly complex for non-public companies, while maintaining a high level of relevance of information for creditors and investors. In the Ukrainian regulatory environment, this Standard is a powerful tool for enterprises seeking transparency and compliance with international standards without an excessive burden on the accounting department.

For the CFO and Chief Accountant, a deep understanding of these sections is the key not only to correctly reflecting figures in the balance sheet but also to effectively managing financial risks, which directly affects the capitalization and investment attractiveness of the business in the long term.

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