This article was first published in the May 2013 Malaysia edition of Accounting and Business magazine.
According to the Roadmap, private entities that meet specified criteria will use the Financial Reporting Standards for Small and Medium-sized Entities (FRS for SMEs), beginning in 2016. The FRS for SMEs is virtually identical to the International Financial Reporting Standard for Small and Medium-sized Entities (IFRS for SMEs), issued by the International Accounting Standards Board (IASB) in July 2009.
Currently, all private entities have the option to use either the Private Entity Reporting Standards (PERS) or the Malaysian Financial Reporting Standards (MFRS).
So is the change welcome? ‘It is long overdue,’ says Chen Voon Hann, managing partner of CAS & Associates. ‘The current PERS framework was introduced in 2006, and there has been no change to the standards since then.’
‘The gap between IFRS and the extant PERS framework is ever widening, rendering current published financial information of SMEs incomparable and/or outdated for the needs of investors, financiers and regulators,’ explains Francis Cyril, partner, audit, BDO Malaysia. Cyril notes that informed investors would be expecting similar levels of reporting and disclosure on a comparable basis with what they are used to in other jurisdictions. According to recent IASB reports, more than 80 jurisdictions have either already adopted the IFRS for SMEs or stated a plan to adopt it within the next three years.
The migration to the new framework will bridge the gap. ‘Our SME accounts will be closer to the global standards, and all stakeholders can focus their resources more on application rather than reconciliation work between the local and global standards,’ says Chen.
But not all small businesses in Malaysia will be subject to the changeover. Under the Roadmap, the financial reporting framework for private entities will use size as a threshold, based on the annual revenue of RM500,000 as the differentiator.
It is estimated that fewer than 100,000 entities are likely to be affected, according to paragraph 24 of the Roadmap. Entities below the prescribed threshold would have the option either to continue applying their current accounting framework (PERS or MFRS) or choose voluntarily to apply the new standard, explains Tan Bee Leng, MASB technical director.
As a result of the demarcation, ‘The profession should brace itself for a three-tier reporting regime,’ advises Deloitte Malaysia executive director Dr Nordin Zain. The tiers will consist of MFRS, IFRS for SMEs and PERS.
Zain also points out that the threshold of RM500,000 in revenue is arbitrary and non-synergistic with the current definitions of SMEs and micro-enterprises set by agencies such as SME Corporation and the Companies Commission of Malaysia. ‘This threshold creates another level for companies to comply with unless there is a plan to streamline it with the current definition or the threshold.’
The diversity of reporting choices might not be ideal, according to Chen. ‘I am of the view that too many choices may complicate the market and confuse the stakeholders,’ he says. ‘Two types of frameworks are adequate, ie MFRS and FRS for SMEs. The introduction of another framework for micro-sized entities may not address the challenges.’ Compliance and disclosure challenges in particular can be burdensome for micro-entities.
Despite these reservations, benefits abound. According to Tan, some of these include helping to improve SMEs’ access to finance, improving the comparability of SMEs’ financial statements with SMEs of other jurisdictions, better preparing SMEs to transition to the MFRS (IFRS) Framework when the need arises, and minimising the knowledge gap between accountants that apply the PERS and those that apply the MFRS Framework.
Cyril stresses that improving comparability of financial information could have tremendous impact by enabling ‘more informed decision-making on the part of investors and financial institutions, which may include foreign funds. SMEs represent a substantial portion of business establishments in Malaysia, and therefore any move to enhance capital and financing flows for this sector will have a significant ripple effect on the overall economy.’
Preparing for implementation
The FRS for SMEs is expected to be released during the first half of 2013. The mandatory effective date will be 1 January 2016 and the date of transition is 1 January 2015. Technically, there will be one-and-a-half years for all stakeholders to prepare for the transition.
People will be the key to a successful transition. ‘At the forefront is having adequately trained staff, well versed with the intricacies of the principles of FRS for SMEs,’ says Cyril. He adds that a paradigm shift in mindset may be required, along with a need to constantly keep abreast of the latest developments in the IFRS ecosystem and the development of skill sets to cater for the requirements of this framework.
Training and education are vital elements to ensure a smooth implementation of the new framework. The owners and finance teams of SMEs need to start learning and preparing for the framework as soon as possible, urges Chen. ‘Investment in training is essential. The data-capturing system needs to be more robust to prepare the data for financial reporting, especially for fair value accounting.’
Meanwhile, SMPs have the opportunities to offer expertise and services to assist their clients to comply with the new framework. ‘SMPs need to invest in learning and development to prepare the team and also change the audit work approach,’ notes Chen. ‘The partners may need to spend some time with the clients to evaluate the need for operating under Sdn Bhd (incorporated body) entities, or convert to partnership or limited liability partnership.’ The choice of business vehicle could affect reporting and disclosure requirements.
FRS for SMEs will prove more complex for preparers and auditors as it introduces fair value accounting, additional standards and enhanced disclosure. The new standards include share-based payment, financial instrument recognition, measurement, presentation and disclosure and related party transactions.
‘These are the few new standards that require robust data-collection efforts, and not all SMEs are ready to provide the information required. The resources for the finance team are always limited, especially for the SMEs. The finance team needs to engage the owners and other department personnel more often for the preparation of financial statements,’ explains Chen.
For example, it is common practice for SMEs to reward their employees with free shares or discounted offer prices. With the introduction of the share-based payment standard under the FRS for SMEs, companies have to account for the fair value of the transactions and report them accordingly. ‘The real challenges are in the valuation model and gathering of data,’ adds Chen.
Meanwhile, Cyril singles out MFRS 139, Financial Instruments: Recognition and Measurement as a standard with far-reaching implications for affected SMEs. The principles encompass recognition and measurement bases for financial instruments and include, inter alia, the manner of classification of financial instruments, the initial recognition bases and on-going measurement, derecognition principles and calculations, and requirements to qualify for hedge accounting.
‘These principles and the definitions of what constitutes a financial instrument cover a wide spectrum of key balance sheet items, including debtors, creditors, cash and cash equivalents, and therefore will have wide-ranging implications on the current financial statements issued by SMEs. Using the issued IFRS for SMEs by the IASB in 2009 as a guide, the requirements of IAS 39 (which is similar to MFRS 139) had been somewhat simplified, incorporating various amendments surrounding classification, derecognition, hedge accounting and derivative financial instruments. Albeit even with these amendments, the principles of this standard will very much provide a number of challenges to SMEs.’
Depending on the level of corporate activity of the SME, IFRS 3, Business Combinations too may pose challenges, says Cyril. ‘Among other complexities, one key difficulty would be the allocation of the purchase price based on the fair values of the assets and liabilities acquired. This of course would only be relevant if there were business combinations applicable to the SME, and does require some level of effort and time to perform correctly.’
Cyril also notes that SMEs that outsource the accounting function will need to ensure that their outsourced service provider has the necessary capabilities to adequately address any matters arising from the transition.
There will also be implications for education. ‘Accounting educators will have to think about a suitable approach to prepare students for MFRS, IFRS for SMEs and PERS,’ says Dr Nordin. All are important, since the first two are globally compliant while the latter affects a sizeable pool of companies in Malaysia.’
Need for simplicity
A recurring theme was the need to champion simplification and ease for small businesses, which are the nerve centre of the Malaysian economy. In an earlier press release, MASB chairman Mohammad Faiz Azmi reported that SMEs represent more than 97% of the total business establishments in Malaysia, and account for some 32% of the nation’s gross domestic product.
Chen notes that avenues are available to ease the compliance burden for small companies. ‘Options are available for them to either operate under sole proprietorship, partnership or the latest limited liabilities partnership, or eventually the audit exemption for small companies regime. These business vehicles can help to ease the burden of SMEs/private entities in complying with international standards,’ he says.
Dr Nordin advocates simplification of financial reporting for micro-enterprises, perhaps along the lines of lodging a two-page financial statement with the relevant regulators.
Inevitably there will be challenges for SMEs required to adopt the new reporting standards. However, in the long run, the benefits should overshadow the short-term adjustments needed.
Nazatul Izma Abdullah, journalist