ED 72 has wide-ranging implications for the future of financial reporting for SMEs. Ramesh Ruben Louis offers a guide to moving away from the PERS ‘comfort zone’
This article was first published in the June 2012 Malaysia edition of Accounting and Business magazine.
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When the Malaysian Accounting Standards Board (MASB) issued Exposure Draft 72, FRS for SMEs (ED 72) on 26 March 2010, many preparers of accounts for small and medium-sized enterprises (SMEs) and small and medium-sized practices viewed this as the beginning of the inevitable end for Private Entity Reporting Standards (PERS), applied by private entities since 2006 and rooted in the Malaysian financial reporting landscape since 1999.
Against a backdrop of plans for full convergence with International Financial Reporting Standards (IFRS) announced by the MASB in August 2008, set to be implemented in Malaysia in 2012, the intention of adopting financial reporting standards (FRS) for SMEs seems to be part of a grander scheme of a holistic convergence, not only for public interest entities but for private entities, too.
Although many preparers and practitioners expected ED 72 to become effective in 2012, it has not yet materialised. However, when it does become effective, Malaysia’s SMEs will have to move from their PERS comfort zone to more ‘FRS-familiar’ territory.
Overview of the draft
The proposed standard is identical to the IFRS for SMEs, issued by the International Accounting Standards Board in July 2009. It is a self-contained standard tailored for the needs and capabilities of smaller businesses. Many of the principles in FRS for recognising and measuring assets, liabilities, income and expenses have been simplified, topics not relevant to SMEs have been omitted, and the number of required disclosures has been significantly reduced. At 230 pages the standard is much less complex (compared with the full FRS/IFRS of more than 3,000 pages), and comes in response to strong international demand from both developed and emerging economies for a rigorous and common set of accounting standards for smaller companies.
The spirit of the proposed standard is to enable SMEs to better gain access to capital. This is because the draft standard improves - or at least is expected to improve - the quality of reporting as compared with many existing national accounting requirements, including PERS. At the same time, it reduces the burden on entities where full FRS/IFRS is applied. Furthermore, it provides enhanced comparability for users of financial statements both within a jurisdiction and across borders. This improves the overall confidence in the financial statements of SMEs.
The standard has been divided into 35 sections which deal with accounting issues relevant to SMEs. These can be categorised into three broad parts: presentation related, financial position related and income/expense related, as laid out in the table overleaf.
At a glance, most of the sections covered by ED 72 have an equivalent under the existing PERS framework. However, it does enlarge the scope of accounting for items that were left out by PERS, most notably on financial instruments, intangibles and share-based payments. The coverage entails a closer inclination towards the FRS/IFRS framework.
Key differences to PERS
Scope and presentation
Currently, subsidiaries, associates and jointly controlled entities of public interest entities can only apply FRS. However, subsidiaries whose parent companies apply FRS are not prohibited from using the proposed standard. This choice can be viewed as an upside as the cost of preparing the financial statements of immaterial subsidiaries of public interest entities can be reduced. However, in order to comply with FRS 127 on using uniform accounting policies in preparing consolidated financial statements, appropriate adjustments will have to be made to the financial statements before the preparation of the consolidated financial statements. Certain quarters see the benefits of simplified accounting and financial reporting for these insignificant subsidiaries being cancelled out by the downside of additional costs and resources for such adjustments.
There are also differences in relation to the presentation of financial statements. Under the PERS framework, an entity prepares a single income statement. However, under ED 72, an entity is to present its total comprehensive income either in a single statement of comprehensive income or in two statements - ie an income statement and a statement of comprehensive income.
Besides that, private entities currently present a statement of changes in equity as part of their full set of financial statements. However, under ED 72, an entity is allowed to present a single statement of income and retained earnings, provided that the only changes to equity during the periods arise from profit or loss, payment of dividends, corrections of prior period error and changes in accounting policies.
Under PERS, there is no explicit treatment for accounting for financial instruments per se. However, under the proposed standard, there is a fair bit of classification and measurement requirements for financial instruments, albeit not as extensive as those contained in the FRS/IFRS framework.
There are two sections dedicated specifically to financial instruments - section 11 for ‘basic’ financial instruments and section 12 for ‘other’ financial instruments. Basic financial instruments are relevant to all entities, which include cash; demand and fixed deposits; receivables and payables; debt instruments; investments in non-convertible preference shares and non-puttable ordinary or preference shares; and loans. ‘Other’ financial instruments relate to more complex financial instruments such as investments in convertible and puttable ordinary and preference shares, options, forwards, swaps, and other derivatives. It also covers hedge accounting.
Essentially, section 11 prescribes an amortised historical cost model, except for equity investments with quoted price or readily determinable fair value. These are measured at fair value through profit or loss. Section 12 on the other hand prescribes fair value through profit and loss to measure the other/complex financial instruments, besides providing guidance on criteria to qualify for hedge accounting, as well as measuring hedge effectiveness. Both sections also provide related disclosure requirements.
An interesting point to note is that ED 72 provides an option to follow IAS 39/FRS 139 instead of sections 11 and 12. However, even if IAS 39/FRS 139 is followed, disclosure requirements from section 11 and 12 are to be followed (not IFRS/FRS7 disclosures).
The use of full IFRSs around world, whether directly or via national convergence, has grown significantly in the past 10 years. At the same time IFRS has expanded and been made more rigorous and more detailed by addressing tough and complex issues. However, smaller companies in Malaysia, including SMEs (the IFRS Foundation estimates there are about 1.8 million SMEs in Malaysia), have expressed concerns that the full FRS/IFRS standards are beyond their needs and capabilities - and the resulting financial statements, while suitable for equity investors in listed companies, are not aimed at the kinds of short-term credit decisions that most users of small company financial statements have to make.
Looking at the Malaysian convergence flight path, it is more likely than not that the proposed standard will eventually take its rightful place amid financial reporting in Malaysia. The million-dollar question is: when? As of March 2012 more than 80 jurisdictions across the globe had adopted the IFRS for SMEs. With Singapore (2011) Myanmar (2010), Cambodia and the Philippines (2010) already adopters, there is indirect pressure for Malaysia to follow suit.
Regardless of the timing, preparers and practitioners cannot be complacent as the SME standard sets forth changes in comparison to PERS on how to measure, recognise and present its financial statement items. Some changes are minimal, while others are fundamentally different. It is therefore imperative to get acquainted with the standard and prepare for necessary changes.
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ED 72 FRS for SMEs - sections
|Presentation-related sections||Financial position-related sections||Income/expense-related sections|
|Sections three to 10 and 33||Sections 11 to 22||Sections 23 to 30|
|Financial statement presentation.||Basic financial instruments||Revenue|
|Statement of financial position.||Additional financial instruments issues.||Government grants|
|Statement of comprehensive income and income statement||Inventories.||Borrowing costs|
|Statement of changes in equity and statement of comprehensive income and retained earnings.||Investments in associates.||Share based payment.|
|Statement of cashflows.||Investments in joint ventures.||Impairment of assets|
|Notes to the financial statements.||Investment property.||Employee benefits|
|Consolidated and separate financial statements||Property, plant and equipment.||Income tax|
|Accounting policies, estimates and errors.||Intangible assets other than goodwill.||Foreign currency translation|
|Related party disclosures.||Business combinations and goodwill.
|Provisions and contingencies.|
|Liabilities and equity.|
1. Other sections besides the above include those on scope of SMEs, concepts, hyperinflation, events after reporting period, specialised activities and transitional requirements..
2. Sections in red indicate no explicit equivalents under PERS.
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Measurement and recognition
|Item||Under PERS||Under ED 72 FRS for SMEs|
|Property, plant and equipment||Cost or revaluation model.||Revaluation model option has been removed.|
|Leasehold land||Part of property, plant and equipment.||Classified either as finance or operating lease, depending on the substance of the transaction. A separate classification; likely prepaid leases.|
|Investment property||Either as property, plant and equipment (under MASB 15) or long-term investment valued using cost or revaluation model (under IAS 25).||At fair value, if can be done without excessive costs. If undeterminable treat as property, plant and equipment.|
|Capitalised development costs||Treated as an asset if the necessary conditions are satisfied and is amortised over their estimated useful life.||Treated as an expense, and deemed to have a finite useful life. If undeterminable, it is presumed to be 10 years.
|Borrowing costs||Allowed to be capitalised||Capitalisation no longer allowed. All borrowing costs are expensed off.
Ramesh Ruben Louis is a professional trainer and consultant in audit and assurance, risk management and corporate advisory.