Great and small
| by Shariq Barmaky, Soh Lin Leng 24 Sep 2008 Topic: Countries, Financial reporting, IFRS |
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Shariq Barmaky and Soh Lin Leng consider plans to introduce differential reporting for SMEs in SingaporeIn May 2008, the Accounting Standards Council (ASC) in Singapore published a consultation paper on a proposed differential reporting framework for SMEs, indicating a positive direction towards exempting SMEs from the full-scope Singapore Financial Reporting Standards (FRS). FRS is modelled after the International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB). IFRS is a comprehensive set of standards aimed at producing high-quality financial reporting that facilitates cross-border transactions and capital-raising. However, due to its complexity, its benefits are better understood and appreciated by the more sophisticated users in the marketplace. There is no doubt that enterprises with high levels of public accountability, such as listed companies and financial institutions, should continue to comply with full-scope FRS in their general-purpose financial statements. However, applying the complex and constantly evolving standards often requires significant investments in time and resources. The question is whether such costs are necessary for smaller private entities, whose financial statements have limited and potentially less demanding users. The study presented in the ASC consultation paper indicated that several countries, including Australia, Canada, Hong Kong, Malaysia, New Zealand and the United Kingdom, plus the European Union, have already adopted differential reporting for SMEs. The IASB has also acknowledged the need for an internationally acceptable set of financial reporting standards for SMEs, with its active project on IFRS for SMEs (now retitled, IFRS for Private Entities). Despite a dissenting view that a second set of financial reporting standards could cause more confusion, there appears to be general consensus that it is acceptable for SMEs to use a simpler, less complicated set of financial reporting standards. Cost-benefit considerations are noted to be the fundamental reason for this emerging trend of differential reporting for SMEs. With experience to be gained from SME reporting practices worldwide, and an active IASB project on IFRS for Private Entities, it is an appropriate time to explore the possibilities of implementing similar differential reporting for SMEs in Singapore. The top-most benefit is definitely cost savings to SMEs. As SMEs form an important part of our growing economy, such a measure would add to the attractiveness of this business segment. The long and due process of IASB's project on IFRS for Private Entities is an indication of the challenges in getting consensus on how SME financial reporting standards should be set; for example, which areas of the full-scope IFRS should be simplified or omitted? More fundamentally, there is a scope question of which types of entity should qualify for SME differential reporting. It is believed the definitions of SMEs and applicability of SME financial reporting standards should be dealt with by respective jurisdictions, and it is a matter of striking a balance between costs and benefits from local perspectives. Public accountabilitySME differential reporting is not suitable for entities with a high level of public accountability, such as entities with publicly traded equities or debts, and financial institutions or entities holding large public funds (including banks and insurance firms). Size of an entity is also believed to be a determinant of its level of public accountability. Larger entities generally have more stakeholders and users of their general-purpose financial statements, including shareholders, creditors, employees, suppliers and customers. To avoid ambiguity in scoping, it will be helpful to first determine a list of specific types of entity required to apply full-scope FRS, regardless of their size. These could include listed entities, regulated financial institutions, public investment vehicles, etc. Entities that fall outside this list will be subject to a further size test to qualify for SME differential reporting. Size criteriaThe ASC proposes that an entity will be deemed to be an SME if it satisfies any two of the following criteria:
While broadly consistent with the practices of several jurisdictions, some aspects are debatable. Firstly, it may be more appropriate to use total assets rather that net assets as one of the size measures. Secondly, clarifications are required whether the size criteria should be determined on a consolidated financial statements or standalone financial statements basis. Thirdly, the suggested threshold for number of employees of 200 appears to be on the high side, as compared with jurisdictions such as Australia, Hong Kong, Malaysia and New Zealand. As there is no hard and fast rule, it might be useful to carry out a market study on the population of private entities based on the three proposed criteria to assess if the quantitative thresholds are appropriate. Other possible criteriaSome private entities - for example, wholly-owned subsidiaries or branches of foreign operation - are set up as service entities with high assets, liabilities or turnover, but which are mostly inter-company balances. They are likely to be scoped out of SME differential reporting, even though full-scope FRS may not be cost efficient for them. To address this issue, we could consider including number of shareholders or amounts of external creditors as other possible indicators for level of accountability. Unanimous consent of shareholders would also be a relevant prerequisite for SME differential reporting, to protect the interests of minority shareholders who are not involved in the management of the entity but want to have access to more financial information. To the extent appropriate, SME financial reporting standards to be adopted in Singapore should be based on IFRS for Private Entities. The SME financial reporting standards adopted should seek to simplify measurement areas involving extensive use of judgment, estimates and assumptions (for example, valuation models and cash-flow projections), and require less onerous disclosure requirements. Qualifying SMEs could be allowed an election of whether to apply SME financial reporting standards or full-scope FRS. Circumstances do exist where it would be more beneficial for the entity to use full-scope FRS. For example, an SME is required to prepare full-scope FRS or IFRS financial statements by its shareholders for consolidation purpose, or is required to prepare full-scope FRS or IFRS financial statements of prior track-record periods for listing purposes. The size criteria of an SME could fluctuate over time and present practical challenges in application. To address this concern, the UK system of allowing the exemption to continue for the first year that the company does not fulfil the size criteria could be a good example to follow. If a qualifying SME is subsequently required to comply with full-scope FRS, it should be given a reasonable grace period to implement the necessary accounting controls and procedures, and prepare comparative information. Going forwardHow would the financial reporting landscape change as a result of implementing SME differential reporting in Singapore? In the extreme, we might see only listed entities and financial institutions in Singapore reporting using full-scope FRS or IFRS. Other enterprises may disregard exemptions if there are good reasons for them to do so. The trend in differential financial reporting is likely to extend to more countries while they adopt IFRS as a model for their national accounting and financial reporting framework, since there will always be a sizeable group of SMEs in each country supporting the need for simpler financial reporting. Therefore, all these initial efforts in formulating an internationally acceptable framework and implementation approach should see their benefits in the long run. Shariq Barmaky is a partner and head of the technical department and Soh Lin Leng is a director in the technical department in Deloitte Singapore. | |