This article was first published in the September 2009 edition of Accounting and Business magazine.
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The principal aim when developing accounting standards for small- to medium-sized enterprises (SMEs) is to provide a framework that generates relevant, reliable and useful information, which should provide a high-quality and understandable set of accounting standards suitable for SMEs.
In July, the International Accounting Standards Board (IASB) issued IFRS for Small and Medium-Sized Entities (IFRS for SMEs). This standard provides an alternative framework that can be applied by eligible entities in place of the full set of International Financial Reporting Standards (IFRS).
IFRS for SMEs is a self-contained standard, incorporating accounting principles based on existing IFRS, which have been simplified to suit the entities that fall within its scope. There are a number of accounting practices and disclosures that may not provide useful information for the users of SME financial statements. As a result, the standard does not address the following topics:
- Earnings per share
- Interim financial reporting
- Segment reporting
- Insurance (because entities that issue insurance contracts are not eligible to use the standard)
- Assets held for sale.
In addition, there are certain accounting treatments that are not allowable under the standard. Examples are the revaluation model for property, plant and equipment and intangible assets, and proportionate consolidation for investments in jointly controlled entities. Generally, there are simpler methods of accounting available to SMEs than the disallowed accounting practices. The standard also eliminates the 'available-for-sale' and 'held-to maturity' classifications of IAS 39, Financial Instruments: Recognition and Measurement.
All financial instruments are measured at amortised cost using the effective interest method, except that investments in non-convertible and non-puttable ordinary and preference shares that are publicly traded, or whose fair value can otherwise be measured reliably, are measured at fair value through profit or loss. All amortised cost instruments must be tested for impairment. At the same time, the standard simplifies the hedge accounting and derecognition requirements. However, SMEs can also choose to apply IAS 39 in full.
The standard also contains a section on transition, which allows all of the exemptions in IFRS 1, First-Time Adoption of International Financial Reporting Standards. It also contains 'impracticability' exemptions for comparative information and the restatement of the opening statement of financial position. As a result of the above, IFRS require SMEs to comply with less than 10% of the volume of accounting requirements applicable to listed companies.
What is an SME?
There is no universally agreed definition of an SME. No single definition can capture all the dimensions of a small- or medium-sized enterprise, nor can it be expected to reflect the differences between firms, sectors, or countries at different levels of development.
Most definitions based on size use measures such as number of employees, balance sheet total, or annual turnover. However, none of these measures apply well across national borders. IFRS for SMEs is intended for use by entities that have no public accountability (ie, their debt or equity instruments are not publicly traded).
Ultimately, the decision regarding which entities should use IFRS for SMEs stays with national regulatory authorities and standard-setters. These bodies will often specify more detailed eligibility criteria. If an entity opts to use IFRS for SMEs, it must follow the standard in its entirety – it cannot cherry pick between the requirements of IFRS for SMEs and the full set.
The IASB makes it clear that the prime users of IFRS are the capital markets. This means that IFRS are primarily designed for quoted companies and not SMEs. The vast majority of the world's companies are small and privately owned, and it could be argued that full International Financial Reporting Standards are not relevant to their needs or to their users. It is often thought that small business managers perceive the cost of compliance with accounting standards to be greater than their benefit.
Because of this, the IFRS for SMEs makes numerous simplifications to the recognition, measurement and disclosure requirements in full IFRS.
Examples of these simplifications are:
- Goodwill and other indefinite-life intangibles are amortised over their useful lives, but if useful life cannot be reliably estimated, then 10 years.
- A simplified calculation is allowed if measurement of defined benefit pension plan obligations (under the projected unit credit method) involve undue cost or effort.
- The cost model is permitted for investments in associates and joint ventures.
The main argument for separate SME accounting standards is the undue cost burden of reporting, which is proportionately heavier for smaller firms. The cost of applying the full set of IFRS may simply not be justified on the basis of user needs.
Further, much of the current reporting framework is based on the needs of large business, so SMEs perceive that the full statutory financial statements are less relevant to the users of SME accounts. SMEs also use financial statements for a narrower range of decisions, as they have less complex transactions and therefore less need for a sophisticated analysis of financial statements. Therefore, the disclosure requirements in the IFRS for SMEs are also substantially reduced.
Those who argue against different reporting requirements for SMEs say the system could lead to a two-tier system of reporting. Entities should not be subject to different rules, which could give rise to different 'true and fair views'.
There were a number of approaches that could have been taken to developing standards for SMEs. An alternative could have been for generally accepted accounting principles for SMEs to have been developed on a national basis, with IFRS focusing on accounting for listed company activities.
However, the main issue here would be that the practices developed for SMEs may not have been consistent and may have lacked comparability across national boundaries. Also, if an SME wished to later list its shares on a capital market, the transition to IFRS could be harder.
Under another approach, the exemptions given to smaller entities would have been prescribed in the mainstream accounting standard. For example, an appendix could have been included within the standard, detailing those exemptions given to smaller enterprises. Yet another approach would have been to introduce a separate standard comprising all the issues addressed in IFRS that were relevant to SMEs.
As it stands
IFRS for SMEs is a self-contained set of accounting principles, based on full IFRS, but simplified so that they are suitable for SMEs. The standard has been organised by topic with the intention that the standard is user-friendlier for preparers and users of SME financial statements. IFRS for SMEs and full IFRS are separate and distinct frameworks.
Therefore, the standard for SMEs is by nature not an independently developed set of standards. It is based on recognised concepts and pervasive principles and it allows easier transition to full IFRS if the SME later becomes a public listed entity. In deciding on the modifications to make to IFRS, the needs of the users have been taken into account, as well as the costs and other burdens imposed upon SMEs by the IFRS.
Relaxation of some of the measurement and recognition criteria in IFRS had to be made in order to achieve the reduction in these costs and burdens. Some disclosure requirements are intended to meet the needs of listed entities, or to assist users in making forecasts of the future. Users of financial statements of SMEs often do not make these kinds of forecasts.
Small companies pursue different strategies, and their goals are more likely to be survival and stability rather than growth and profit maximisation. The stewardship function is often absent in small companies, with the accounts playing an agency role between the owner-manager and the bank.
Where financial statements are prepared using the standard, the basis of presentation note and the auditor's report will refer to compliance with IFRS for SMEs. This reference may improve SME's access to capital. The standard also contains simplified language and explanations of the standards. The IASB has not set an effective date for the standard because the decision as to whether to adopt IFRS for SMEs is a matter for each jurisdiction.
In the absence of specific guidance on a particular subject, an SME may, but is not required to, consider the requirements and guidance in full IFRS dealing with similar issues. The IASB has produced full implementation guidance for SMEs.
IFRS for SMEs is a response to international demand from developed and emerging economies for a rigorous and common set of accounting standards for smaller and medium-sized enterprises that is much easier to use than the full set of IFRS.
It should provide improved comparability for users of accounts while enhancing the overall confidence in the accounts of SMEs, and reduce the significant costs involved in maintaining standards on a national basis.
Graham Holt is an examiner for ACCA and executive head of the accounting and finance division at Manchester Metropolitan University Business School